Chinese firm’s advice: forget cap-weighted indexes

Pension funds need to look at building a “new beta system”, according to Dr Henry Zhao (pictured), moving away from traditional global indexes in general and cap-weighted indexes in particular.

Dr Zhao, the chief executive of one of China’s largest fund managers, the $38 billion Harvest Fund Management, says that while efficient market theory supports the use of cap-weighted indexes in developed countries, it is no longer appropriate for emerging markets, whose economies are expected make up more than 50 per cent of world GDP within the next 20 years.

“There are a lot of empirical studies which show that emerging markets are not as efficient,” he says. “Theories based on the efficient-market hypothesis are not true for emerging markets.”

Emerging markets, such as China, are dominated by retail investors who have different methodologies to institutional investors. And often, market-disclosure statements do not reflect all the information which is available about a company.

The result is that information takes a lot longer to be disseminated and digested in emerging markets than in developed markets.

Dr Zhao spoke at two Mercer Investments conferences this week, in Singapore and Melbourne, on the subject: ‘Investment Strategies for Non-Efficient Markets’.

His two main pieces of advice for pension funds which have gone global are: re-weight to emerging markets; and “go deeper” to develop a good understanding of the countries, cultures and markets invested in.

“Every country is different,” he says. “It’s important to have local knowledge to get alpha … You have to build a new system to help you think this way.”

Examples of winning strategies for the China ‘A’ Shares market include big-picture thematic strategies, those with a growth bias and bottom-up strategies. An example of a losing strategy is to invest in Chinese ‘blue chip’ stocks.

“Big is not necessarily better,” Dr Zhao says. The problem with cap-weighted indexes is they lead the investor to overweight the larger companies, rather than small- or medium-sized ones, and developed countries rather than developing. They can also trap investors in share market bubbles.

D Zhao believes that “real” indexes are better benchmarks, which look at factors such as GDP at the country level and balance sheets and fundamental growth prospects at the stock level.

“People think of beta as being neutral or passive – it’s not, it has biases. People don’t realise that.”

Harvest was one of a group of 10 Chinese fund managers licensed in the late 1990s, which marked the start of the modern Chinese funds management industry. There are now more than 60 offering mutual fund and institutional asset management services.

In 2005 the Deutsche Asset Management acquired a minority stake in the firm and has assisted in its internationalisation. Harvest formed an international arm, Harvest Global Investments, in Hong Kong in 2009, which manages about $4.8 billion, of which $2 billion is sourced through the parent.

Late last year, the firm formed an alternatives platform, Harvest Alternatives, of which the first fund manager is a Hong Kong-based hedge fund, JT Capital. The aim is to roll-out a full range of alternative investment strategies, including private equity and infrastructure, in which the parent takes minority stakes.

“We think it is important to share the ownership,” Dr Zhao says. “The most important capital is intellectual capital and human capital.”