Last week has been quite the week for anyone who pays attention to the China market.
From an unexpected joint press conference by the People’s Bank of China (PBOC) and its Securities Regulatory Commission last Tuesday, to a more unexpected Politburo meeting last Thursday, to an even more unexpected follow up announcement from the PBOC last Sunday, the double-barrelled shotgun of monetary and fiscal stimulus measures have been fired from the very top of China’s governing echelon. Ray Dalio calls it a week that “could go down in market-economic history books.
Pent up animal spirit appears to be unleashed. The Shanghai stock exchange experienced transaction glitches. Banks are having trouble processing orders from retail clients, while brokerages are staying open late to process all the demands. And this “All-in Buy China” spirit (from “Anything But China” not too long ago) has spread to retail investors in the West, few of whom could pronounce Pin-duo-duo properly, but feeling mad FOMO.
Since Interconnected Capital has been consistently overweight Chinese tech (much more overweight than Mr. Tepper), as we disclosed in our last two quarterly letters, I can’t complain. This euphoria, however temporary, does beg a bigger question: is China investable now?
In the last four years, anyone who has even an ounce of knowledge about the China market has had to answer the insufferable question, “is China investable?”, at least a handful of times. This question seems ludicrous on some level – of course, the second largest (or largest depending on how you measure) economy in the world is not just going to disappear. But it is not without merit, depending on who the questioner is.
At this fascinating juncture, it is worth examining why this question needs to be asked in the first place, by whom, and what the underlying reasoning portends for China’s economic future.
Capital is Political
The “is China investable” question is actually a legitimate one, and remains legitimate even in light of last week’s stimulating activities. That’s because the world’s major sources of capital are becoming increasingly political in nature. Thus, financial return is no longer the only measuring stick; most institutional capital allocators must consider the political and reputational ramifications of their decisions as well.
Let’s look at each major capital allocator category – sovereign wealth funds, pension funds, and endowments/foundations – in the context of the China question.
Sovereign wealth funds are the easiest ones to understand. These funds are literally formed by the governments of different countries with the money that belongs to that country, oftentimes generated from selling its natural resources. The archetypal examples are the ones formed by countries in the Middle East (the Public Investment Fund of Saudi Arabia, Mubadala of the UAE) and the Norges Bank of Norway, arguably the largest one of this category.
They are formed by governments, and therefore must serve both a political and a financial purpose. Thus, the market of countries that are deemed politically toxic will take a backseat. China has not yet been deemed that by Norway (Norges is still a large shareholder of Alibaba and other Chinese companies). However, for the Middle East, China could be trending that way, given that the region is trying to become a major player in AI and playing a delicate role in between the US and China to access the best technologies and talent – what I called the swing vote of global AI competition. Because the US holds the upper hand in AI, outfits like G42 which are deeply connected with the sovereign wealth ecosystem of Abu Dhabi, are divesting away from China in order to curry favor with the US. In this instance, China is not investable.
(There was a rumor recently that US officials are drafting proposals to form an American sovereign wealth fund. If this rumor becomes reality, you can be sure that anything related to China is not investable.)
Pension funds share many similarities with the sovereign wealth funds. Any pension fund that works on behalf of government employees are, by definition, political in nature. A great example is Calpers, the state of California’s employee pension fund (and the largest of its kind in the US). As an extension of the California state government, thus under the scrutiny of politicians, it cannot simply act as an economically rational actor and invest in whichever opportunity has the best return profile. This designation explains the departure of its former CIO, Yu Ben Meng, whom Republican lawmakers made a target of having problematic China ties (though he seemed to have had some personal double-dealings that tripped conflict of interest wires as well). Pension funds throughout the US and Canada are major sources of capital globally. And much of that capital has been moving away from China for both economic and political reasons.
Endowments for universities and foundations, on the surface, are the least political of the three major categories. Nevertheless, as political issues increasingly permeate all types of institutions, they aren’t immune either. Endowments of public universities are the most sensitive, due to their nature as quasi-government institutions funded and beholden to their respective state governments. Prominent examples are the University of Texas System Endowment and the Regents of University of California. Private universities’ endowments, especially the prestigious ones like Harvard and Princeton, are increasingly scrutinized for political reasons as well. This scrutiny is not strictly reserved for China. Harvard’s endowment has been stuck between a rock and a hard place recently – wealthy donors withholding donations due to the school’s sympathetic stance towards pro-Palestinian (interpreted as pro-Hamas) causes, while activist students demand that the school divest from assets related to Israel for the opposing reasoning.
Over the last four years, since China’s drastic policy turn towards disciplining many of its tech industries in late 2020, American endowments and foundations, from the University of Chicago to the Robert Wood Johnson Foundation, have been phasing out their exposure to China. Even though they still visit the country to gather information on the ground, the discussion centers more around when and how they can exit their current investments, rather than pouring more money in.
All this is not to say that pension funds and endowments no longer have exposure to China. Quite the opposite. According to a report by a non-partisan trade organization, Future Union, large institutions like the Maryland State Retirement and Pension System and the University of Michigan Endowment have made investments into China as late as 2023. But these would-be innocuous activities five years ago are getting covered by CNBC, forcing every one of these institutions to field reporter questions and defend their activities.
It is no wonder the question of “is China investable” still gets asked so often. Implicit in this question is a slightly different question: “is investing in China worth the trouble?” It is not about economic return, but about reputational damage and political scrutiny.
There is one major category of capital allocators I did not mention: large family offices. This category has the least institutional baggage and is perhaps the most economically rational actor of all capital allocators – which brings us to the most vocal “China bull” of the day, David Tepper.
The “Everything, Everything” Strategy
Founder of Appaloosa Management and owner of the NFL team, Carolina Panthers, David Tepper made a viral appearance on CNBC the morning after the unexpected Politburo meeting, where he unequivocally said he is buying “everything” China. (This “everything” mantra is not a one-time thing; Tepper uttered more or less the same strategy in 2010, also on CNBC, for buying everything in the US market, near the end of the Great Financial Crisis.)
His big bets on Chinese tech companies like Alibaba and Pinduoduo were disclosed in 13F’s in the previous two quarters. Asking to be on CNBC that morning was no doubt a victory lap. And even though he comically cannot pronounce Pan Gongsheng (head of the People's Bank of China) for the life of him, Tepper is not a China tourist per se when it comes to investing.
In the mid-2000s, Tepper made successful bets in commodities, like steel and coal, as a strategy to benefit from China’s torrid economic growth a few years after entering the WTO. Earlier in this career, he invested to catch the bottom of the debt crisis that vexed Latin American countries in the 1990s, like Argentina and Brazil. He is no stranger to betting heavily in the emerging markets, though he is by no means a China expert (nor does he pretend to be).
What’s interesting to think about is that had Tepper not converted Appaloosa into a family office in 2019, and no longer managing outside client’s money just his own, would he have had as much freedom to allocate as heavily into a politically toxic but economically appealing (or, at least, cheap) market like China?
Judging from a previous episode in his career, Tepper has learned a hard lesson that freedom from outside investors is key to success. In 2000, Appaloosa was short the NASDAQ but had to cover its short positions due to outside investor pressure, five weeks before the tech bubble popped. He called that failure “one of the worst trades of his career” and vowed to never let outside investors mess with his decision making. It would be hard to imagine him, or anyone, having the freedom and flexibility to bet so heavily on China this year, if say Calpers or Harvard were his LPs. Not impossible, but definitely slow and difficult.
Up to now, China is only investable for the few, like Tepper and Michael Burry of “The Big Short” fame, who have achieved so much success in the financial world that they now command sole authority of their investment decision making. They do not need to answer to (or give a damn about) the whims of outside investors, an investment committee, a congressional committee, or public scrutiny. But 90% of the world’s capital still does.
Will last week's events materially change the perception problem of investing in China? I would not bet the farm on it.
Chinese policymakers may have given the stock market a bottom, but the whole economy is far from a clear turnaround. China’s stimulus may be coming fast and furious, but it won’t shake the “adversary” label vis-a-vis the West anytime soon. Thus, behind the closed doors of most investment committees, the “is China investable” question will still get asked.
That of course does not prevent Tepper, Burry, or me and other independent rational actors from executing the “everything, everything” strategy. Frankly, if or when a string of pension funds or endowments starts to publicize the success of their China allocation, it is probably time to sell.
If you are interested in David Tepper’s story, I highly recommend Frederik Gieschen’s profile of his career.