China plays reclassified as risk capital

A long time ago I placed a chunk of my savings into a portfolio of Hong Kong-listed shares, including pure China plays, and left it there, untroubled by downturns and without temptation to take profits in the upturns. These are long-term holdings.

I no longer consider these investments to be appropriate retirement savings, however. In my own head I have reclassified them as risk capital.

China’s economic risk is a known known: the country expanded quickly and unevenly, and must make an uncertain transition to a more consumption-driven growth model. Bears say this is not possible without a massive crash first, to recognise losses incurred in the “debt-fuelled asset bubble”.

Bulls point to the substantial structural underpinnings. There is vast room for wealth-boosting productivity gains. Many consumption markets are not even close to saturation levels, and the urbanisation process is far from over.

I have been in the bull camp when it comes to the economic fundamentals. The problem is that political risk is becoming harder and harder to assess.

The anti-corruption campaign, even if well-intentioned and justifiable, is unpredictable in its execution and has considerably raised the risk premium. Hardly a month goes by without another company head disappearing, having either fled the country or been detained. Bankers, fund managers and companies have been dragooned into a communal market-supporting effort. A bearish commentary could lead to detainment or 15 minutes of fame by way of a televised confession.

We see billions of dollars fleeing the country and it is hard to argue that this is just related to the stock market slump or the weakening yuan; the money was leaving even when the stock market was booming, likely amid uncertainty about the scope and goals of the anti-corruption campaign. Tightening repression of free speech and civil rights might also be adding to the sense of insecurity.

Hong Kong corporates are also obviously affected by these trends on the mainland. Do they have the political skills needed for operating in today’s China?

In Hong Kong, rich people are so coddled and worshipped, that they can say almost anything and get away with it. For instance, I attended a lunch a couple of weeks ago in which the speaker was Ronnie Chan, chairman of Hang Lung Properties. In classic Chan style, he boasted that he had raked in 80 per cent profit margins on several local residential developments, thanks to the “stupidity” of the Hong Kong government.

The stupid thing the government did was not release enough land supply during the previous downturn. So Hang Lung just held onto its inventory and waited until the recent years’ bubbly conditions to unload.

Can one imagine a Chinese developer boasting about fat margins gained thanks to the supply-management stupidity of mainland officials? Of course not (anyway, in China developers have time limits to develop land after a purchase, or else they are forced to lose the land).

Chan’s tone seemed to change when he moved on to discuss his company’s investments on the mainland – or as he kept putting it, the “motherland”. He is very approving of the administration of Xi Jinping. “Several years ago I started to fear about the future of China, because ... people were telling me how angry they were about corruption,” Chan explained. These fears have faded, thanks to the aggressive stance Xi has taken to root out corruption.

As an operator of high-end malls on the mainland – and luxury has been hard hit by the campaign – it is just possible that Chan’s feelings on the matter are a bit more nuanced.

The fact is, we can never know. Chan might truly feel that China’s long-term stability is guaranteed by the current undertakings, but if he did not, he could not publicly express those concerns. Doing business in China requires extremely sensitive political skills, including showing proof of patriotism towards the motherland. One foot-in-the-mouth utterance could have huge economic costs.

Moreover, imagine how minority investors would feel if a company chairman suddenly turned “outspoken,” or accidentally let slip some unorthodox private view, like if he or she happened to think that “those TV confessions look really unconvincing”.

Sad to say, as investors, we would dump their shares in a heartbeat. This is not the stuff of which nest-eggs are made. This is risk capital.

Cathy Holcombe is a Hong Kong financial writer