Despite some obstacles, sovereigns and central banks prefer China for investment

With COVID-19 still a worldwide concern, the impact of the pandemic is a major theme in investment decisionmaking. This includes an examination of adjustments made in response to the crisis and the impact on long-term trends, including a growing interest in China.

China's appeal has steadily increased over the past four years, driven by attractive local returns and opportunities for diversification. With its relatively successful response in managing COVID-19 apparent to investors, 40 percent of investment sovereigns see the country as a more attractive investment destination than it was prior to the pandemic.

This is what we found in our ninth annual Global Sovereign Asset Management Study. The study detailed the views of 141 chief investment officers, heads of asset classes and senior portfolio strategists at 82 sovereign wealth funds and 59 central banks, who together manage $19 trillion in assets.

Sovereigns' intentions to increase allocations to China is unsurprising. The study reflects that sovereigns see increasing potential in the country, as the score of its economy has risen from 5.2 in 2017 to 6.6 in 2021.

Indeed, this year, China was perceived to be the second most attractive economy in which to deploy capital in the major economies surveyed. COVID-19 has influenced the uptick of China's score since 2019, as China's response to the pandemic has positively impacted sovereigns' view of the country.

China acted swiftly to minimize transmission and reaped the rewards through a comparatively strong economic performance, as life continued relatively unscathed.

According to the survey, over the next five years, 40 percent of sovereigns plan to increase allocations to China. Up to 75 percent of sovereigns are keen to invest in China due to the prospect of attractive local returns, and a further 57 percent see China as an important portfolio diversifier.

Over the past year, domestic stock indexes have performed well, buoyed by innovative technology companies, and the increasing access enjoyed by sovereigns has also revealed private market opportunities, particularly within infrastructure.

One Asia-Pacific investment sovereign said they "have been investing in private equity opportunities in China since 2016 and returns have almost been as phenomenal as the growth in the volume of capital being deployed to Chinese private equity itself".

Favorable consumer themes such as an emerging middle-income group and a highly digitalized economy only strengthen sovereign appetite for allocations to China.

Aligned with sovereigns, central banks have also continued increasing allocations to Chinese financial assets, driven by diversification away from the US dollar.

While all currencies benefited from this diversification, the renminbi was one of the main beneficiaries, with average allocations at 2.3 percent as of the end of 2020, versus 1.9 percent a year earlier. More than half－53 percent－of central banks in the study now hold the renminbi, versus 40 percent in 2018.

Looking ahead, 40 percent of central banks are considering new asset classes in the next two years, with emerging market debt as the most popular new asset class. This is driven by banks making their first allocations to China.

We believe China sovereign bonds are likely to be a key asset class for sovereigns and central banks going forward, especially with these bonds included in major global indexes and as initiatives such as the bond connect between the Chinese mainland and Hong Kong have made cross-border trading more accessible and efficient.

Although most central banks maintain their renminbi holdings within their longer-term investment portfolios, the study indicated that investors are increasingly comfortable with this currency and see benefits of maintaining exposure.

China's rise as an economic and political superpower has inevitably influenced sovereign allocation decisions. Sovereigns are proactively diversifying their portfolios to take this into account, while passively increasing exposure through China's increasing representation in broad emerging market equity and bond indexes. The pros to increased allocations in China are numerous and offer a compelling investment case.

However, sovereigns stress that the positives must be weighed against obstacles to investment.

Despite China's growing appeal, there are some notable obstacles to investing. Up to 86 percent of sovereigns point to Beijing's rising political tensions with Washington as a major barrier to investing, and political risk was the top obstacle cited as having changed for the worse in the past two years.

Other obstacles investors noted include the inconvenience in converting the renminbi (cited by 50 percent of sovereigns), and a lack of alignment of investments with ESG considerations (45 percent). ESG refers to a set of environmental, social and governance criteria used by socially conscious investors to screen potential investments.

It is noteworthy that, should the obstacles ease, investment and liquidity sovereigns would increase allocations to China. Investment sovereigns are bullish on the China opportunity and are keen to build upon what are often sizable existing allocations.

As one North American liability sovereign explained, "there is no way you can ignore this market. Even with this geopolitical environment, China still offers the largest market for sustainable energy and infrastructure, as well as an abundance of development property and luxury lodging opportunities."

Currently, investment sovereigns and development sovereigns have the largest allocations to China, at 7.2 percent and 6.8 percent, respectively. Going forward, investment sovereigns are the most bullish on the China opportunity. Besides, development sovereigns－while deeming the China opportunity attractive－h(huán)ave proactively built up their current China allocations and are largely at optimal allocation levels.

In conclusion, with China's growing economic standing and the potentially attractive returns available on the Chinese mainland, it seems likely China will be a popular choice for years to come.

To address uncertainties, some are continuing with the establishment of offices in the region, notably in Hong Kong. As another North American sovereign explained, "We will make the most of these investment decisions internally and will look more closely at the opportunities there. We opened up Singapore and Hong Kong offices to look closely at Asia and especially China to see where it is going before putting capital there."

The writer is chief executive officer for Greater China, Southeast Asia and South Korea at Invesco, a global asset manager. The views don't necessarily reflect those of China Daily.