Funds face a little trouble with big China

Concentration risk pushing managers away from benchmarks

LONDON, Nov 11, (RTRS): China is heading for such dominance in the world’s main emerging market stock index that investors are scrambling for ways to water down the too-many-eggsin-one-basket risk.

Among the options on offer are standalone China-dedicated funds and even trying to move further away from investment benchmarks themselves.

China — increasingly dominant in all spheres of economic and politics — currently accounts for around 24 percent of MSCI’s emerging market stock index, which is tracked in one way or another by around $1.6 trillion in investments.

This means that a losing day in Shanghai can mean a losing day for emerging market investors as a whole. But the impact is expected to balloon in coming years when almost 400 mainland China-listed stocks — known as Ashares — are added.

That will take China’s weight up to more than 40 percent.

It is already starting to grow. On Thursday, MSCI will announce the inclusion of around 14 US-listed Chinese companies such as web giants Alibaba and Baidu in its EM stock index.

That will boost China’s share in the index to around 25.6 percent, according to estimates by HSBC analyst Vijay Sumon, whilst Korea, Taiwan and Brazil could see their weightings fall by about 21-43 basis points each.

This, however, is small potatoes compared with the changes expected when A-shares meet the criteria for inclusion — not just for so-called passive investors who simply track the index but also for active managers who move their allocations within the general bounds of the index.

Deviate The latter — whose holdings comprise some $1.3 trillion of the total — face restrictions on how much of their portfolio can deviate from the index.

“They have to be very careful they don’t stray from the benchmarks as measured by the tracking error,” said Nitin Dialdas, chief investment officer at Mandarin Capital in Hong Kong. Tracking error measures how closely a fund follows the index to which it is benchmarked.

“A 15-20 basis points tracking error for the large guys is probably acceptable, more than 50 basis points is probably pushing it,” Dialdas added.

If a country is no more than 10 percent of the index, this constraint isn’t a problem, but once China swells to over 40 percent of the index, investors buying a global EM fund will have a significant exposure to a single market.

“Country risk is the biggest source of risk for an emerging markets investor, and the nature of benchmarks often leads to an over-concentration of country risk which would make many investors uncomfortable,” said Mathieu Negre, head of emerging market equities at UBP. In an attempt to overcome this, UBP is converting an existing fund into a new structure that will decide its own country weightings using top-down macro research.

“Structurally it will be underweight the biggest countries and overweight the smallest countries. Over time this should deliver lower volatility versus the benchmark, thanks to better diversification,” Negre said.

Others, such as William Palmer, comanager of Barings’ Global Emerging Markets fund, take a “benchmark agnostic” view. This means he doesn’t feel compelled or obliged to invest in any company or country just because it is in the index.

Instead, a third of his fund is “offbenchmark” meaning he just selects the stocks he likes, cutting some country exposures to zero or buying companies not included in the index.

Some investors, including Palmer, are not waiting for A-shares to enter EM indexes, despite a rollercoaster ride on mainland Chinese stocks this year. The index slumped more than 30 percent in less than a month from mid-June, after rising 50 percent in the first half of 2015.

Continued from Page 30 Iran’s fleet includes 37 to 40 NITC supertankers, known as VLCCs, each capable of carrying 2 million barrels of oil. Tanker tracking sources estimated that Iran was currently storing oil — both crude and its derivative condensate — on around 24 VLCCs versus 29 vessels in July.

Euronav’s de Stoop said eight of Iran’s supertankers, currently used as floating storage, were over 15 years old and were

unlikely to rejoin the global fleet as it would involve millions of dollars in extra costs.

Lawyers say EU companies are likely to face fewer limitations in dealing with NITC than US firms, which would complicate early deals given the importance of the US financial system.

“Financing and insurance of NITC or its vessels or voyages will present challenges,” said Matthew Oresman, counsel with law firm Pillsbury.

“US financial institutions will not be able to play a role and initially few European financial institutions may be

willing to insure and finance these transactions initially, especially if they have had sanctions compliance issues in the past.”

Shipping and legal sources say the risk of a possible “snap-back” in sanctions, if Iran does not meet its commitments, is also likely to add to caution when dealing with NITC for now.

“If you put yourself in the shoes of a client before he would accept to charter an NITC vessel, he would have to think probably twice whether there is a risk attached to the fact that sanctions could be re-imposed,” Euronav’s de Stoop said.