Livecast #15: Dr. Liqian Ren on China Markets & Macro
Liqian Ren 任丽倩, Ph.D., is the Director of Modern Alpha at WisdomTree Investments where she manages, among other things, an ETF focused on non-state owned companies in China using quantitative strategies. She was a quantitative portfolio manager at Vanguard for 11 years, worked for the Federal Reserve Bank of Chicago, and has an MBA and a PhD in economics from the University of Chicago. Hear about:
Why macro is usually not the main or only factor when it comes to investment research;
Why investors should be more discernible to headlines and rumors when investing in China;
How much the demographic slowing down, the decline in birth rates actually affects Chinese equities;
The risk of the VIE, the variable interest entity, and potential de-listings of Chinese equities from US exchanges;
The overall regulatory environment and regulations that were impacting tech in particular;
Why Liqian believes the Evergrande crisis is not contagious;
Liqian’s predictions on sectors that will have great opportunities;
Follow Liqian on Twitter and her company blog at wisdomtree.com/blog
[00:01:20] Rui: Hey everyone. Welcome to today’s Livecast. Today’s conversation is not going to be specifically about China tech, because we have with us a generalist investor Liqian Ren. You might’ve seen her on Twitter. She is a very experienced portfolio manager and she has a background in macro economics. So we’ll be asking her questions around that. Now Liqian, can you give us a brief introduction of your background?
[00:01:49] Liqian: Thank you, Ray. Thank you for having me. I joined WisdomTree three years ago. Currently it’s an ETF shop, if you pay attention to our press releases and we are also [00:02:00] very much into digital assets, not just crypto. We manage your portfolios across asset classes and countries.
[00:02:06] We are quantitative systematic shops, so we’re not fundamental managers. For example, for emerging markets, we have strategists that only invest in non-state owned companies, not just in China, but in India and whole emerging markets.
[00:02:20] We try to bring something new and extra, but all strategies need to be systematic. So that is something a little bit different. Sometimes when news happens, we cannot, do not react very quickly because we have a systematic strategy to make portfolio decisions.
[00:02:39] My own background is in quantitative investing and managing active funds. Actually, I help implement strategies that combine the outperformance potential of active management with the benefits of the ETF structure. For people who don’t know this structure as well, it has certain tax advantages compared to [00:03:00] traditional mutual funds.
[00:03:01] Before WisdomTree, I was a quantitative portfolio manager for Vanguard for 11 years, and I was also an associate economist at the Federal Reserve Bank of Chicago. I Was trained as a software engineer at Peking university, but ended up having lots of classmates who are pioneers in China tech.
[00:03:20] Rui: Thanks for giving us that background, Liqian. As I was saying earlier, I started following you on Twitter because I noticed you had some really great macro takes when it comes to China tech. And that obviously comes from your background as an economist.
So I know that you said your strategy has to be very systematic, but what are some of the basic considerations you look at when you invest in China that you can share with us?
Liqian: Yeah. So first, it’s very important to keep in mind that macro is one factor, but usually is not the main or only factor when it comes to investment research. Even though in the media, I think also on [00:04:00] Twitter, it seems like macro is an overwhelming factor, but in reality, it is not. It’s usually not even the top one factor. For example, for our China strategist, it is an index based strategy. We only invest in China non-state owned companies.
[00:04:18] The thing to pay attention to is, are they making money, having quality growth. Keep in mind, the economy is correlated with the stock market, but not that high. Actually, if you see the US economy for a while, it was not doing that well, but the stock market was doing great.
[00:04:35] So I think these things people generally forget, if you don’t specifically work in this area. Sometimes they understand that in the US, the economy and the market can be a little bit disjointed in the short term, but when it comes to China, they forget.
[00:04:51] The last thing when it comes to China and you’ve talked a lot is to be discernible to headlines and the rumors. So I think when it comes to China, there are more of these things. And most people do not realize that the majority of the Chinese economy is private. It’s not public. If you pay too much attention to news, you feel the government is calling all the shots, but that’s not the fact on the ground. So all these things in our research we track them, but sometimes it also tries to convey this to investors.
[00:05:25] Rui: When you say the things that you’re conveying to investors, you mean ignore the rumor.
[00:05:30] Liqian: We try to explain to our clients what’s going on. I’ll just give one example this year, China equity. Everybody says China equity is bleeding, and the truth is it’s much more focused on China tech and also China tech that is listed offshore.
[00:05:48] If you look at China, Asia, depending on the day, it’s doing okay. It’s either positive or close to zero. And for China’s small CAP, they’re doing even better than a lot of [00:06:00] others. So for this particular year, value has done well because of the commodity boom. That’s a result of a lot of government stimulus because of the pandemic.
[00:06:12] Usually (when) value doing well means energy and financial sector. So the energy and financial sector, generally is overrepresented in Chinese state companies, right? Most of the top energy firms and top banks are state owned. So because of that macro background, those companies have done well and China tech has not done that well. [00:06:36] But that doesn’t mean over a longer period, the non-state economy will not outperform the state economy. So for this year, you really need to separate a lot of headlines from what’s the general macro background.
[00:06:51] Value and growth has been back and forth. Value generally is energy and financials, and growth is generally tech and that’s [00:07:00] similar in the US as well.
[00:07:02] Rui: All right. Going back to some market factors that you were saying earlier that are maybe overblown in terms of their impact, especially on equities. There are a couple narratives out there that I hear a lot, and I get a lot of questions about that I want to discuss with you.
So the first is population change. I know you have some really strong opinions on whether or not the population change actually affects Chinese equities that much. I’m talking about the demographic slow down, the decline in birth rates. [00:07:35] Do you think it matters all that much?
Liqian: Yes. Actually, I don’t worry about population growth at all. And this could be very much on the margin, because obviously in China, there are a lot of governments trying to worry about population. But if you look at population change, it’s a very slow moving variable.
[00:07:55] In the last, I would say a hundred years, if you look at who are the worst forecasters in social science, usually economists are not that good. Financial people are slightly better than economists. But the worst are the population experts.
[00:08:13] If you look at the history in 1960s, lot of population research centers got funded in the US, that’s because every headline in the six days was worrying of population bomb that the world is going to be having so much population, we are going to be in the food shortage. The world is going to the dune. And all these forecasts are completely off.
[00:08:37] And the manner of the fact is, China has a disaster, a one child policy, which is driven by a lot of these population experts’ opinions, which is very sad.
[00:08:48] So even if the population gradually reduces in the near 20 years, and you can see in Japan, Japan is 20 years ahead of many other countries, it’s not a disaster. I wouldn’t put population growth as part of the investment factor.
[00:09:05] And actually about 20 years ago, there were a lot of academic papers in the US which said the baby boomers are going to retire and sell, the stock market is going to be going down. And now you look back 20 years, that forecast has turned out to be completely bogus as well.
So I think in terms of population, you have to trust that people generally like kids, and generally make good decisions to manage these kinds of slow moving variables.
[00:09:34] Of course, you want to make it easier for women and men to have kids, to raise kids. China, I think, is starting to realize that some of the policies women still face significant workplace discrimination, which some of it is subtle. And I think that some of those changes are a double edged sword. If you mandate a very long maternity leave, then actually, companies will be a little bit hesitant to hire women.
[00:10:07] So I think putting trust on people, on them making a decision for their own family is the best. In China, the more that people make the party feel there’s a fear of population decline, the more the party feels obligated or feels pressure to do something knowing that it’s this terrible experience of one child policy. I think what much prefer to leave the state out of this.
[00:10:33] Rui: I don’t think that’s going to happen though. I think the state is going to be very, very involved in managing the population. So we’ll see how that goes.
All right onto the next narrative, which is about the risk of the VIE, the variable interest entity, and potential de-listings of Chinese equities from US exchanges, which you also have some strong opinions about. So tell us about it.
[00:11:00] Liqian: So I think for people who are not familiar with it, VIE is a variable interest entity, and de-listing is a US law, which has a three-year window of Chinese companies listed in us. First, these two issues are two separate issues. They need to be evaluated separately.
[00:11:20] For VIE, it is about Chinese companies that try to get around Chinese law, because China does not allow private capital or foreign capital in a few areas like education or communication or in the earlier days kind of e-commerce, but e-commerce, I think, is a legacy issue.
[00:11:41] So Chinese companies use this VIE structure. Essentially, if you buy a stock of Alibaba, you are actually buying an offshore shell company that has a contractual relationship with the onshore company. So you don’t own the company outright.
[00:11:55] Now VIE (that) has been in the US was thought up by [00:12:00] a Chinese lawyer who happened to go to Peking university, and he worked at the ministry of law. So he understands what kind of things can satisfy both the US capital market and the Chinese government. So he came up with this VIE idea to get around these Chinese laws. For more than 20 years, China does not want to recognize it. So it never openly says it’s legal or it’s illegal, just having a strategic ambiguity, but actually in the last two or three years, the favor is moving for VA companies.
[00:12:35] First, VIE companies got listed in China, which is really a very huge deal for people who don’t follow this detail. This essentially says China is recognizing VIE.
[00:12:46] And the second thing is, usually China’s security market is a little bit ahead of other regulators. In the last two years, VIE companies are being treated the same as other Chinese companies. When [00:13:00] they filed for antitrust regulation, that was issue many VIE companies like Baidu, or Ctrip (携程) has been lobbying for it and China resisted. Finally, last year and this year they are being treated the same as non-VIE companies.
So if you look at these policies, things going on the ground, actually VIE companies are starting to be recognized more as a legal structure than an illegal structure. Vie companies actually are getting the legitimacy they always crave for in the last 20 years. And that’s reflected in Chinese regulations.
For example, a VIE company like DiDi in older days can list in the US, but doesn’t have to go through the approval process like other Chinese companies. Now they’re going to treat it similarly, so that you’re going to have to seek Chinese onshore approval before a VIE company can list offshore. This is not yet official, but the [00:14:00] best case scenario for a VIE company is to be treated just like any other Chinese company in the legal and regulation framework.
[00:14:07] Delisting is a separate issue. Of course, a lot of companies facing delisting risks happen to be VIE companies. So there’s this overlapping over list, but delisting is because US passed the law last year says if China’s auditors for companies need to be subject to regulation by the US super regulator, the PACOB (Public Company Accounting Oversight Board).
[00:14:32] So China has resisted because originally it feels that it’s part of the Chinese intermediate audit before the final audit of Chinese companies can be shared with US regulators. But actually China’s security regulator came out with an official kind of a Q&A, and in it, they hinted that they are working with the US SEC (Securities and Exchange Commission). It’s a three year time window. So if China and [00:15:00] US can work out these technicalities, whether auditors, keep in mind it’s the intermediate auditing documentation, could be shared with the US. So there is still hope.
[00:15:11] On the other hand, because a lot of these Chinese companies already do listings in Hong Kong, in the larger broad China’s space, there are really only 28 companies, about 6% of the weight. That’s yet to do a list in Hong Kong and the US. As a portfolio manager, we already switched a majority of our portfolio of those companies to Hong Kong trading, just to hedge the risk.
[00:15:34] I think a lot of people are confused that the Chinese equity has been done a lot and it’s because of VIE and delistings, but I would argue that if you drill down, it likely has much to do with China’s economy not growing as people have thought.
If you remember one year ago, you look at all the sales side of the forecast from Goldman, from IMF, from World Bank, it’s all glowing 8.5%, 8.6% of China growth. And then the first quarter, it shows that China was not growing that fast. So China equity, the earnings growth was not as high as people were thinking because the economy was not doing as well. So I think that is one significant factor.
[00:16:17] And of course, Chinese regulators also did a lot of things that shake some confidence in China equity. But I think the VIE and delisting issues by themselves are not necessarily the main factors.
[00:16:31] Rui: I totally agree. I’ve been saying that for a long while as well. So as you pointed out, VIEs used to be somewhat residing outside of the official legal system, but now they’ve been fully incorporated and they’re being treated just like other Chinese companies.
[00:16:46] I mean, we won’t know what happens to this exact structure going forward. They may have more restrictions, but it’s hard for me to imagine that this entire thing will be dismantled without at least some sort of replacement mechanism.
[00:17:02] All right, so let’s move on. Regulations. You had mentioned that this was a huge theme for this year. Now. I agree with that obviously, but I only focus on tech. So I only looked at the regulations that were impacting tech.
[00:17:23] How do you think it compares to what’s happened in these other industries? And what is your opinion of the regulatory environment overall? What are some of the things that may be those of us who focus exclusively on tech or mostly on tech probably missed and that you think we should know about
[00:17:43] Liqian: Yeah. So I think your characterization, I fully agree that there are three types of regulation. One is like China idiosyncratic ones, and some of it is catch up ones like China’s regulators catching up with business. And some of it is actually China in front of other businesses.
[00:18:02] It seemed to be so focused on tech. I think it’s because tech companies are a big part of a China equity portfolio. So if something is done to Alibaba, everybody knows.
But if it’s something that’s done to some state owned energy companies, like this year, China has changed because of the energy crunch, China’s Fagaiwei, the national reform and development commission came out with so many directives in terms of loosening electricity trading, [00:18:33] I think people are not paying attention because the companies that’s been impacted are mostly state owned coal companies. There’s a little bit of a disconnect which is people paying more attention to China tech because that’s a very big part of a typical China large and mid CAP portfolio.
[00:18:50] Rui: What about some of the other sectors that you look at? I know you’re also following the Evergrande crisis recently. So you were looking at real estate.
[00:18:59] Liqian: If you actually look at it from a portfolio point of view, real estate is less than 5% of a typical China portfolio. So if it’s just contained within real estate, generally the impact is not going to be very high. The problem is real estate is 20 or 25% of China’s economy, depending on how you measure it, and its contribution to China’s growth is pretty large. So if the economy is slowing down because of the Evergrande situation, then it impacts the whole China. So that is why I was paying attention to Evergrande, even though Evergrande by itself could be a very small portion of a portfolio.
[00:19:41] In the early confusing days, I said I don’t believe it’s contagious, mainly because a lot of other real estate firms generally have good quality measures, good balance and also Evergrande was really a special case in the sense that it was highly leveraged. It has mismanaged its [00:20:00] own company and China already has a lot of experience winding down these kinds of large company defaults. So that’s how I made the call that it’s not going to be contagious.
[00:20:11] Also Evergrande is already known. One year ago, people already knew Evergrande was asking for capital help, left and right. So I think if the company’s bad news is generally known, then it’s unlikely to be a significant contagion effect, but still, it does have an impact because you can see that the banks tightened lending to real estate for about one month.
And then you hear PBOC was really working behind the scenes to try to redirect banks to start lending to the real estate sector again. So the lending has picked up a little bit, but I think again, going back to the population growth in China, the three areas, real estate, education and healthcare, considered three big burdens of a middle class.
[00:20:59] So what people don’t remember is that actually, healthcare regulation happened two years ago. There was a significant complaint about how expensive drugs are, how expensive healthcare is.
[00:21:10] China has done some regulation in terms of how they purchase health care services. And the healthcare companies’ stock prices went down a lot and then bounced back. But the healthcare sector is not as big as the China tech sector.
And this year, together with Chinese regulation, together with US regulation and also China being a very political topic, just amplified all these regulations that were directed at China tech.
[00:21:38] Rui: Right now that you mentioned, I am aware of the healthcare regulations, the central purchasing. I think that’s still going on, right? I regularly see news about the story of that drug coming under the national procurement strategy. But I just don’t follow enough of it to really know.
One last question. We are now at the beginning of a new year, and everyone’s starting to make predictions about what’s going to happen in these next 12 months. What are some of the things that you’re focused on that you think are especially interesting that maybe you think the rest of us aren’t looking at as closely and we should?
[00:22:13] Liqian: I believe China tech is still going to be very big part of any investment portfolio, but I’m much more a broader China investing kind of person, particularly I think healthcare is going to be the next sector that’s going to be tracking a lot of attention and investments. There was a list of, you can call it bio weapon, biology related Chinese companies and Chinese institutions that got into the US sanction list.
[00:22:43] I think that generally is a sign that there is significant investment going on in China in this sector. All aspects of healthcare and drug development, devices, biotech, there will be a lot of opportunities there. [00:23:00] So I do feel it’s an area people probably could pay a little bit more attention on China tech.
[00:23:06] You know more than I do about China tech, my feeling is that there is a little bit crowdedness. Usually when industry gets competitive, the profit gets competed away a little bit. So these companies will be looking for growth in other areas, like Tencent, JD, they are moving into the health industry, even just online pharmacy.
[00:23:29] In green energy, I believe that there will continue to be very big growth because China is very dependent on imported energy, particularly oil. The only thing that kind of helped China and India is coal. China has an abundance of coal, even though it’s very polluted. It’s the only source of energy China has a lot of control, so I don’t think coal is going away.
Now there is disagreement between solar and nuclear.[00:24:00] Nuclear is highly state owned in China. If you look at the supply chain, at least for now, a lot of the value adds are state owned companies.
[00:24:09] I don’t know enough to see whether there will be movement in that area. I think China will be very careful to go, but in other green energy, like solar or wind, there will be a lot of investment in these areas. But for investors you have to be very discerning how to pick the companies.
[00:24:27] Just use the electric vehicle as an example. People need to understand, if they bet on one or two, that’s gonna require a lot of fundamental research. Ours is much more index based, so we have some exposure, but mainly based on cap weighting.
[00:24:43] Rui: Right. I think electric vehicles last year didn’t do that well as equities, if you were only in the vehicles. But if you were in the underlying battery technologies, I know that the three leading companies, CATL, Great Wall, and BYD, you would have done really well. That’s definitely something we’ll have to cover on a podcast in detail very soon. All right. I think that’s all we have time for today. Liqian, what is the best way to reach you?
[00:25:11] Liqian: Thank you everyone. The best way to see what I do is still on Twitter and also our company blog, at wisdomtree.com/blog. Again, we are a global shop. My work is not just in China, but also in emerging markets, in India, in Japan, and in factor research. So if you are interested in those areas, I think I highly recommend you check out .
[00:25:34] If you have any quality factor, how we think about quality, those kinds of most specific issues, feel free to ask me directly on Twitter.
[00:25:42] Rui: Thanks so much everyone. And thanks Lee for your time.
[00:25:48] Liqian: Thank you.