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Wall Street takes China with reservations despite upbeat rhetoric

Afool, if you are lucky, you can get amazing returns by betting on the coin toss. However, they risk losing everything in the process. The investor’s end result is a high return adjusted for the risk associated with it, the idea best known as the “Sharpe ratio”. That takes the asset’s expected return minus the risk-free rate an investor could earn by parking their money in super-safe government bonds, and divides it by the standard deviation, a measure of return volatility. A ratio above one is considered good. Double or nothing coin flips have a negative Sharpe ratio.

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Western financiers who have invested or plan to invest in China have such calculations in their minds. The risks associated with the country have grown over the past three years. Power appears to be more concentrated than ever in the hands of China’s leader, Xi Jinping. His attitude towards business has been erratic: he has left technology companies including Alibaba and Tencent in trouble; Alibaba’s Ant Group was forced to cancel the 2020 US stock market listing, and a series of executives disappeared. The latest missing person is Bao Fan, the boss of Huaxing Capital, who was reported missing on February 17. Shares of the investment bank plunged 50% before recovering slightly.

Relations between China and the West continued to deteriorate. The United States introduced huge subsidies to promote the development of indigenous industries. This month, it shot down an apparent Chinese spy balloon. The prospect of China eventually invading Taiwan, and the West’s readiness to impose sanctions, as indicated by the measures imposed on Russia, have raised the prospect of further economic alienation between the two powers.

China’s rewards, however, are enticing. This has been the case for a long time, but not to the extent that it is now. The country is opening up after years of a ten-trigger lockdown. Given China’s economic strength, a rebound in economic activity as Chinese people start to patronize restaurants, travel and shop again means China alone could provide most of the momentum for global growth in 2023 and 2024. Perhaps the exposure to growth juggernauts, after adjusting for all these risks, is worth it.

There are rowdy supporters on both sides of that position. On February 15, Charlie Munger of Berkshire Hathaway, known for being bullish on China, praised local companies as “better, stronger” and cheaper than their American counterparts. He also played down the idea that China might one day invade Taiwan. In contrast, Jeff Gundlach, an analyst at bank JPMorgan and bond investor Jeff Gundlach, called China “uninvestable” (although analysts at JPMorgan later changed their minds).

In private, however, financiers are more cautious and are reducing their exposure to the country. The boss of a private equity fund said that while his firm still sees an opportunity in China, it is adjusting its approach; avoiding any businesses that might end up in vicious supply chain disputes.Berkshire Hathaway to reduce stake BYDa Chinese electric vehicle manufacturer, and TSMCa strategically important Taiwanese semiconductor company, in the last quarter of 2022.

The most comprehensive information on foreign investment can be found in balance of payments data, which tracks financial and trade flows. The data show that “portfolio flows” (such as investments in stocks or debt securities) into China have increased in recent years before turning sharply negative in 2022. They’re released with a lag: The latest figures don’t reflect reopenings. Real-time evidence on traffic is mixed. Despite gains in stocks and some evidence of modest inflows into mutual funds, outflows from exchange-traded funds have continued so far this year, according to Bloomberg data.

It shows some fear among the best minds on Wall Street. Even if they don’t like to say it in public, concerns about Xi Jinping and Taiwan will prevent them from embracing China. Perhaps the best way for western financiers to get rich is not by putting their capital at risk by investing in Chinese companies or stocks, which could get hammered at the whim of the government, but by offering wealthy Chinese investors what Wall Street does best Serve. Last month it was reported that Chinese assets under management at investment firm Bridgewater Associates, which debuted an onshore fund in 2018, had doubled to nearly $3 billion. Such work has the added benefit that it does not need to be justified by calculations involving Sharpe ratios.

Correction (March 3, 2023): An earlier version of this article stated that Ant Group was forced to cancel the “U.S.” public offering. In fact, it had planned a joint listing in Hong Kong and Shanghai. sorry.

Learn more from our financial markets columnist Buttonwood:
Investors expect economy to avoid recession (February 15)
Soaring Stocks Ruin the Sacred Investing Rules (February 7)
The Last Breath of the Meme Era (February 2)

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