Should global investors own Chinese assets? Q&A with Sofia Horta e Costa

Originally from Lisbon, Portugal, Sofia Horta e Costa is a Hong Kong–based Bloomberg reporter who covers all things connected to China markets. She also tweets a weekly thread every Friday that provides a summary of must-read stories you need to know about if you’re interested in business and finance in China — here is this week’s installment.

I spoke to Sofia by video call on April 14. This is an abridged, edited transcript of our conversation, part of my Invited to Tea interview series.

—Jeremy Goldkorn

This has been a mad year for covering the Chinese economy and Chinese companies, whether they’re listed in mainland China, Hong Kong, or the United States. We now have a war in Ukraine, and COVID and the extreme lockdowns in Shanghai and elsewhere playing havoc with logistics companies’ plans. Hong Kong is about to get a new chief executive, whose main achievement seems to have been playing a major role in the suppression of demonstrations and protests in the city.

And it’s only April.

So how does this all look from your perspective in Hong Kong? Are investors in the financial community in Hong Kong running for the hills? Or do they see proverbial blood in the streets and are still ready to invest?

This is the most interesting part of what’s happening in Chinese markets because Hong Kong is really at the intersection between domestic China and the rest of the world. So seeing it from here, you do see a sudden distrust of China from the global investment community.

If we were talking five years ago to investors, if you didn’t have China exposure, what was wrong with you? And now there’s kind of a big rethink. Does it make sense for a global investor to own Chinese assets?

And you say it’s been this year, but also last year: Every single action that Beijing seemed to take was at the expense of shareholder interests. So repairing that was already difficult. And now when you throw in what’s happening with Russia, and China’s refusal to get off the fence… And we had the warning yesterday from Janet Yellen, which was really interesting to me because it really seems that, from the U.S. at least, the concern is that China is really not backing away from its friendship with Russia, nor Xí Jìnpíng 习近平 from his friendship with Putin.

So it’s really the trauma of the last year. And when you put on the extra political layer and the strongman view that people now have of Xi Jinping and of Putin, that really makes people think, at least from a political risk perspective, from an ESG perspective, Chinese assets, are they really worth having?

It’s not just the risk. It’s also the fact that returns are really poor. Chinese stocks have been one of the worst performers this year, after already a pretty bad year last year. And when your potential future returns are so low…I was looking at my spreadsheet and the only market that’s offering worse returns than China right now is Sri Lanka. When you consider that and add all the political risk at a time when everywhere else in the world is starting to get cheaper, people are really asking themselves, is there a point to being in China?

When you talk about low returns, how does that compare historically? Because to some extent, there’s always been the sense with China investment from the outside world that it’s a bit like technology investment. That a lot of it is not based on fundamentals, but on hopes and dreams for the future?

Hopes and dreams, yes, but it was really an economic success story. You mentioned tech. If you look at China’s tech story, the giants Tencent and Alibaba, they were offering huge returns for investors. When Tencent listed in Hong Kong in 2014, [it was priced at $0.47 per share. At its peak last year, it was $46.85.]

When you consider that type of growth, people were essentially just buying China for the growth story and it didn’t matter how risky the investment was. And this is really the case for high-yield bonds in the property space. People were just buying these 12% percent, 14% yielding high yields, junk dollar debt, and they weren’t really looking at the companies. Because it didn’t matter, because it was China. China was a fast growing economy. People wanted to buy homes. People were buying second, third homes, and that would never stop. But it is stopping now. And it’s really a big reality check for a lot of international funds.

Is there a meaningful distinction between Hong Kong and mainland China in the minds of bankers and investors anymore?

That’s a question that has been asked repeatedly since 2019, especially when we had the pro-democracy protests here. And in the aftermath of the national security law that was introduced in mid 2020. Because Hong Kong is a place that has, essentially, arrested all anti-establishment parties, and removed any kind of political opposition. Journalists have been arrested as well. So freedom of speech has been very much a concern.

For a banker though, there was a concern at the time that it would reduce the attractiveness of Hong Kong as an international financial hub. But actually what you saw happen was people became just more certain of Hong Kong, because of the stability brought about in the aftermath of the national security law. So actually 2020 was a really good year for markets. It was an amazing year for Hong Kong IPOs. And it was really a money-making time for many people here. And that’s because of the stability brought about by the crackdown, which is obviously controversial, but greed doesn’t discriminate with political systems.

But now it’s a very different story. I think now the political risk and what you saw happen in Russia has really…The trauma there of, essentially, your holdings overnight being written down to zero. International banks having to pull out from one day to another. Big global businesses stopped doing business in Russia.

There is a real question of, what if this happens to China? And even if the probability of this happening is extremely low, but China is, in many ways, just so much more important than Russia. Much bigger economy, much bigger financial markets, its trade relationships with Europe and the U.S. are a lot stronger. But what if?

And that “what if” for a lot of funds, and for a lot of people that I’ve been speaking to recently is enough, essentially, to pull out.

The counterargument of that is you have seen the likes of JP Morgan and other Wall Street banks really investing heavily in China. They’re hiring, they’re expanding. They still want a slice of that market for their business. It’s still a very profitable business because China is liberalizing its financial industry, but it’s a very, very interesting interplay right now. I think we’re in a moment where the narrative is shifting.

How much of this sort of new early Western banker discomfort with China do you think could be attributed to COVID lockdown measures and border closures?

My sense of, at least some of the financial community in Hong Kong, is that they don’t care. Beat up the protesters, lock them up, ban the newspapers, who cares? But now the bankers can’t leave Hong Kong and travel freely. Things have gotten too much! Is that a factor, do you think?

I think you’re right. There are two things here:

Hong Kong is an international financial hub, and international means global businesses and experts. Anecdotally, a lot of expats have left. That had a lot to do with how Hong Kong’s government treated children. For example, children were separated from their parents. There were awful stories there. And also there was no real game plan. What would happen? What was Hong Kong’s plan in the long run to kind of exit the COVID-zero mentality? We had no visibility. I think the outflows of talent in February and March [this year] were some of the most severe since the first cases of COVID were known in early 2020. So it was really a huge factor for the international community here.

Interestingly, there was also a flow of Chinese nationals going back to the mainland because Hong Kong was such a mess. And what we are hearing now is some of those people who went, for example, to Shanghai, are now feeling a bit let down with what’s happening in Shanghai. Because they’re thinking, hey, we left Hong Kong because the situation was a mess, but actually the government in Shanghai is not really doing much better.

So there is a little bit of disenchantment on both sides, both the international community and the Chinese community.

You’ve reported on China investors learning how to profit from Xi’s new capitalism. We also did a piece on what to buy in the era of common prosperity. Is this just wishful thinking or are people figuring out strategies that may actually work to deal with the new reality? Or has all of this just been completely upset by the war in Ukraine and the new waves of COVID?

There are people who do still want to invest in China, and there are plenty of investors and there’s plenty of capital still there. There’s an increasing realization that if you want to make money and if you want to not get burnt like people were burnt last year, you really have to read the tea leaves. You have to invest alongside the interests of the Communist Party. And if you do that, you’re fine.

In terms of the equity market, there are industries that are very much in favor: Anything related to green energy, EVs. That’s a very, very clear priority. What’s kind of the red, the no-go areas, that’s anything that has to do with social media, anything that hooks children on things that seem to be unhealthy. Unhealthy habits. You want to get away from that. Also monopolies, the internet platform companies, gaming…

So it’s more of a sense that, well what is common prosperity? [But] can you be prosperous when the economy is under so much pressure? Will common prosperity even work this year? That’s a big question. But investing alongside the interests of the Party, and if we can be even more specific than that, investing alongside the interest of Xi Jinping and what his ideologies are, that is the new profitable investment strategy in China. And you can’t do it any other way.

Some last questions that have nothing to do with your job: You run ultramarathons, right?

I do. Actually, I broke my ankle in November, sadly, so I’m still recovering from that. But the longest one I did was 100K in Hong Kong, which is one of the most beautiful places to do it in. My first one was in Mongolia, in the Gobi Desert. And that was 70 kilometers. That was really difficult because we had gale force winds that we had to run against. They even closed the airport, but we ran anyway and we were running alongside these wild horses. It was stunning.

I love running, but it’s also a really good way to go into very, very remote parts of cities, of places, because you have to go quite far.

Have you got one planned for when your foot recovers?

I’m doing a half marathon tomorrow. See how that goes. I can only do them in Hong Kong because it’s impossible to travel out of the city right now. I’d be quite keen to do the 100K again, the same route. It’s called the MacLehose Trail. It’s very famous here in Hong Kong

My name is “Goldkorn,” and I get weird questions about my name, so if I may take the liberty: What is the origin of your surname, Horta e Costa?

It means “garden and coast.” It’s a made-up name. My family was on the wrong side of a civil war a while ago, in the 1800s. And we had to make up a name and they just put two names together. It’s like a vegetable patch and coast, more than a garden and coast.

Well, Goldkorn is a kind of not very nice bread from Eastern Europe.

There we are.

Invited to Tea with Jeremy Goldkorn is a weekly interview series. Previously:

‘Ugh, here we are’ — Q&A with Geremie Barmé