Perspective: APG & E Fund in China

Any business venture will ultimately be judged by what it yields. In the case of the almost five-year partnership between the €568bn APG, Europe’s biggest pension provider, and E Fund Management, one of China’s largest asset managers with CNY2trn (€260bn), the experience so far has been fruitful.

APG deputy CIO Ronald van Dijk, speaking in early April, points to annual 10-12% above-index return for the flagship concentrated equity strategy, which invests in about 27 mainland China A-share stocks. 

APG and E Fund signed their agreement in 2016. Unlike other joint ventures between Western and Chinese asset management entities, the deal did not involve one taking an equity stake in the other. 

Neither does it involve a straightforward investment management agreement, since APG’s preferred ESG strategy was not available in the asset management market at the time. And nor does it involve a pure knowledge transfer or loose co-operation, as evidenced by the resources that both sides have committed – in the case of the equity strategy this is two portfolio managers (junior and senior) and an ESG analyst each, making a team of six. 

There is also no direct involvement with China’s retail asset management market, which can be frothy and subject to high levels of churn. In fact, as van Dijk points out, the sentiment-driven characteristics of the Chinese equity market are a driver for generating above-market returns. 

Sau Kwan, who leads the venture from the E Fund side as president and head of global strategy, says there was an early realisation in discussions between the two sides in 2016: “We don’t want them as a client, we want them as a partner. We have a lot of things in common,” was the refrain.

For E Fund, the partnership offers the opportunity to become a “thought leader”, to innovate and set the trend in the development of the industry. The concentrated, long-term equity strategy is a relative novelty in China, and replicates APG’s approach in other markets. Sau says E Fund’s senior management takes a keen interest in the qualitative aspects of the venture.

A three-pronged equities strategy
At a global level, APG takes a three-pronged approach to active equities – with quantitative, traditional ‘medium term’ fundamental and ‘long-term’ concentrated portfolios.

The concentrated portfolios are where APG can do real leg work in ESG, and China is no different. The limited number of positions (27 at the time of writing) allows for in-depth analysis of each company, and, together with an agreed minimum holding period of five years, also for on-going engagement. 

Engagement is where APG brought know-how to the venture. E Fund brought ‘boots on the ground’ research and access to corporates. This is important for APG given the difficulties of language and culture in a market where engagement by investors with c-suite management was unheard of, and APG had little initial recognition.

The venture with E Fund birthed APG’s direct foray into A-shares, but was not its first investment into Chinese companies, having previously invested via Hong Kong and directly in real assets and infrastructure in its private markets portfolio. APG’s Hong Kong based emerging markets team also invests in Chinese companies, but separately from the E Fund venture.

APG and E Fund equity team members all work in their separate respective offices in Hong Kong and Guangzhou (in APG’s case the location outside mainland China is for regulatory reasons). 

The fixed-income set-up is different, with E Fund effectively advising APG’s four-strong team. The two APG portfolio managers are in Hong Kong, while the two analysts are in Beijing, in close proximity to E Fund’s fixed-income capabilities.

Sau, van Dijk,  along with Kathy Xu, APG lead portfolio manager for equities, and Gregory Suen, head of China fixed income for APG, all see the teams as cohesive units in their own right, despite the location differences.

The challenge of engagement
For Xu, the initial stage in 2018 was about creating the chemistry and establishing the investment process. Then came the challenge of how to do the engagement.

“We sat down and concluded that between the PM [portfolio management] team,” she says. “We list out the three top engagement issues, the most important things we want to engage each company on, so everybody’s on the same page. Then when we see the companies either together, or individually. That makes the engagement work more efficiently.”

Xu points to engagement in related party transactions, where the team has been successful in limiting these; in encouraging small and mid-cap companies to increase disclosure on supplier frameworks, thereby increasing transparency and ESG ratings; and getting companies to limit investment of free cash in riskier wealth-management products.

She says: “There are quite a few engagement successes. We use a positive engagement approach and hope that the ESG average company can become ESG good, and the ESG good companies can become ESG great.”

The four-strong fixed-income team runs a similarly concentrated portfolio of about 20 issuers with 50% in quasi government (policy bank) bonds, and the rest in corporate credit. There is also an ESG focus. 

Speaking from Hong Kong, Suen says the concentrated nature of the portfolio does not raise liquidity issues at the moment as it is still relatively small.

There are no fixed expectations for the ultimate size of the portfolio but Suen expects it to grow meaningfully. Index inclusion for Chinese fixed income (recently announced by FTSE as of October 2020 with a phase-in period of three years; Bloomberg Barclays Global Aggregate Index integration started in April 2019 was completed last December) is expected to accelerate interest in onshore bonds. Foreign holdings of China on-shore bonds are still only about 3% of the market.

“The fixed-income market is the second-largest in the world and it’s very little represented for most clients so I think there’s quite a bit of room to grow in terms of exposure,” Suen says.

“Something that we expect to change gradually with more foreign participation is on the ESG side. International investors are obviously more focused in this area, and even more so in the past couple of years,” he says.

“Secondly, I think with foreign participation there will be credit risk pricing, maybe more differentiation between different credits. That’s something that we have seen taking place recently, but I think it will be another thing that will progress even further.”

In part due to APG’s bottom-up fixed-income process and the integration of ESG analysis, the team does not consider green bonds per se, despite the growth in issuance in recent years.

“We need to look at the issuers themselves, whether they’re doing the right things or have best practices on ESG rather than just their label,” Suen explains.

“We don’t keep track in terms of how many green bonds we have, because for all the companies that we invest in we have a good understanding of them and we feel that they are doing some of the right things in terms of ESG before we invest in them.”

As there is little overlap between the equity and bond portfolios, there is little opportunity or need, so far at least, for the teams to leverage their activities.

Some aspects of the fixed-income process take time, Suen adds: “We spend a lot of time on each of the companies to analyse them, to understand what are things that they can do better, and then engage with the companies to try to make them improve”. 

Van Dijk also points to the quicker responses required for fixed-income in contrast to equities, for instance due to the issuance process.

“The process is much faster because when there’s an issue coming to market. You need to speak with the issuer and need to respond very quickly, so the interaction between the APG team and the E Fund team on the fixed-income side is far more important.

“The APG office in Beijing is around the corner from the E Fund office so they visit each other quite regularly. The physical presence is important for fixed income, because the dynamics are different than for equities.”

For van Dijk, investment in China is a distinct skill-set in itself. He points to elements like market microstructure, culture, language and governance, as well as the sheer size of its bond and equity markets both in terms of overall volumes and number of stocks or issuances.

“If you say, is it an asset class or not, it’s always a difficult definition. But it requires different skills to invest in China than in other markets, because it has its own special dynamics. 

“You saw with the corona crisis, not only the virus itself, but also the economic impact from it and the recovery, that China is largely uncorrelated or lowly correlated with the rest of the [global] economy. It behaves differently to Europe and the US in terms of returns, has its own cycle, its own dynamics in economic growth, and the business cycle is different. 

“China behaves differently to Europe and the US in terms of returns, has its own cycle, its own dynamics in economic growth, and the business cycle is different” - Ronald van Dijk

“So in that way we need to understand what’s happening in China and E Fund helps us to understand and to explain what the economy is doing, what the focus points of the government will be in the coming years in the preparation of the five-year plan, in risk insights, as well what is happening in this enormous market.

“We profit from a trusted party that is connected to local industry. They know the companies, they have feet on the ground. You cannot get that knowledge when you’re in Singapore or in London.”

From E Fund’s perspective, Sau emphasises that a collaborative culture is no accidental occurrence. “What makes our partnership work is the chemistry of people. A lot of times we disagree and sometimes debate. But at the end we look at the bigger picture, what are the important things for both organisations and the partnership? We look at the facts and make decisions objectively. 

“That is not easy to replicate – the human factor, the chemistry, the company culture, those money cannot buy.”