The troubles facing highly indebted property developers in China have dominated conversations about the Asian nation’s economy and markets this year. Yet according to Rayliant Global Advisors’ Jason Hsu, there’s an important distinction between this and past housing crises elsewhere which is guiding policymakers’ response to it: The developers are the ones who are over-leveraged, not the households.
(Bloomberg) — The troubles facing highly indebted property developers in China have dominated conversations about the Asian nation’s economy and markets this year. Yet according to Rayliant Global Advisors’ Jason Hsu, there’s an important distinction between this and past housing crises elsewhere which is guiding policymakers’ response to it: The developers are the ones who are over-leveraged, not the households.
Hsu, the chief investment officer at Rayliant Global Advisors, joined the What Goes Up podcast to discuss the state of the property market as well as the consumer in China. Here are some highlights of the conversation, which have been condensed and edited for clarity. Click here to listen to the full podcast, or subscribe on Apple Podcasts or wherever you listen.
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Q: Lay out the problems with the property real estate sector in China.
A: When you think about apartments from the US perspective, you buy it to either live in it or you rent it out to collect the yield. In China, there are lots and lots of apartments that are owned but not lived in and not rented, so it’s very unproductive. Chinese don’t think of apartments as producing an income for you. They think of it more like a store of value, so they’re perfectly happy holding an apartment, leaving it empty, believing it holds value. So from that perspective, there’s enormous demand when it comes to Chinese appetite to buy property.
Are the developers in trouble because maybe the Chinese are cooling off on their preference to hold wealth in real estate? I’d say the Chinese developers are mostly in trouble, not because somehow Chinese investors have had a shift in taste. What’s more an issue is a lot of them have simply geared up way too high. Country Garden, your China Evergrande that went under last year — they simply borrowed way too much debt, and they were hoarding land and hoarding apartments, not selling them fast enough to pay down the debt. They just irritated Beijing a little too much. And I would say these are not a real estate-related triggering of bankruptcy, but almost a policy engineered bankruptcy targeted at real estate developers that have simply become too levered up.
Q: What’s been the policy response?
A: The government doesn’t think right now there’s a meaningful problem in the real estate sector other than that consumers seem to be disappointed about how real estate is performing, and therefore that lack of confidence may be causing them to not consume. So the government realizes the most reliable channel for wealth effect — basically real estate appreciating which has caused households to increase consumption — that channel has temporarily gone away. But the bigger problem they’re trying to contain originally was that they didn’t want real estate prices to get more expensive. It wasn’t becoming a financial problem; it was becoming a social problem.
Chinese households are not levered when it comes to real estate. Developers are very levered, but households — which is far more important — they’re not levered.
So I think the government is OK with where real estate is today. Prices aren’t going up. The bankruptcies you’re seeing in the developer sector are very engineered. On the household side, there’s not a balance-sheet crisis because they’re not buying real estate on leverage. So they really don’t think there’s a meaningful problem there. Now, of course, they wish Chinese households would have found another store of value or another asset that’s more productive that the government could help manage and create a wealth effect. And they’re hoping the stock market can be that.
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Q: You launched a China ETF at the end of 2020, and it’s down since the launch. Talk to us about the strategy and why the early couple of years have been rough.
A: The beta has been a major, major headwind. We launched a product at a time when we believed that as China gets incorporated more into the MSCI basket, there’s going to be a natural flow going into the asset class, and people are going to start to get more curious about, oh, can you directly invest in China rather than just buying Alibaba as an American ADR. So we launched an onshore product that focuses on A shares — and of course we ran headlong into essentially three years of turbulence all the way from the Covid lockdowns to the government experimenting with policies of how to manage e-commerce platform companies. There’s just a lot of uncertainty with regard to what that will look like.
Early signs have not really caused people to develop confidence. And certainly you got the China-US tensions that started with President Trump and continue with President Biden. So we ran into a lot of beta headwinds — unexpected, of course. But it is, I would say, par for the course when it comes to investing in emerging markets.
Q: Where do you see opportunities in emerging markets right now?
A: I would say short-term, the interesting and fun plays are really all the “friend-shoring” themes. Those could last all the way from a few months to perhaps a year or two. You have Mexico now being front and center for a lot of people thinking, hey, friend-shoring Mexico is an obvious candidate as an EM economy that’s big enough and obviously close enough to the US. India. Vietnam being where a lot of Chinese entrepreneurs and factories have moved production to. I would say there are a lot of opportunities around the friend-shoring concept — that’s in the short term.
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But in the long run, where I think the opportunities are, it’ll continue to be the export-oriented and high-value-add economies — your China, your India, and increasingly so your Vietnam, Indonesia as more foreign direct investments leave China to go to these smaller economies. They’re going to follow the Japan, South Korea, Taiwan, and, of course, the China model of exporting. And then through exporting, improving corporate profits, improving GDP growth. And I’m probably a bit more mixed about purely resource-based emerging-market economies because they seem to go through these boom-bust cycles that are just driven by commodity prices. Now, commodity prices could sustain the current high levels due to geopolitical tensions. But without a really strong value add, I’m a little less fond of pure resource-oriented emerging-market economies.
Listen to the rest of the podcast here.
–With assistance from Carolina Wilson and Stacey Wong.
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