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Enter the Dragon

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And just like that, another Lunar New Year is upon us. In the coming days, billions of hopeful people worldwide will be celebrating the auspicious shift in cosmic energy that a new turn of the zodiac wheel portends. Don’t know about you, but I can hardly wait to emerge from this Rabbit hole of a year and embrace the mythical Dragon, a creature of unparalleled splendour, traditionally associated with power, nobility, honour, luck, and wisdom. What more could you wish for?

While the festivities keep some Asian markets closed next week, investors might perhaps take the opportunity and reflect upon what the year of the Wooden Dragon holds for the region’s economy and markets. China, for one, has been the cause of many a headache lately as the country’s triple whammy of debt, deflation, and demographics have battered the market in general and the real estate sector in particular. Money has been flowing out of Chinese funds and even foreign direct investments have turned negative, for the first time in decades.

So, should investors rejoice at the impressive rally that Chinese stocks staged just ahead of the holidays or dismiss President Xi’s attempt to prop up the market aided by the buying spree of China’s sovereign wealth funds? Is the uptick an auspicious sign to jump on the back of this rising Dragon or would you just get burned again by its fiery breath?

For most responsible investors, of course, the question is much thornier than that. To keep or not to keep having exposure to China has been a contentious topic at many investment committee meetings for the past couple of years at least. The number and intensity of the red flags certainly match those at a Tiananmen Square victory parade. Take geopolitics, for instance. These are truly worrisome times. The scary example of pre-invasion investments in Russia, still fresh like an open wound in investors’ minds, is begging the unavoidable question of whether Xi could be the next Putin.

Even those willing to brave the tensions around Taiwan and the regime’s general aura of dictatorship, however, might have difficulties disregarding detailed reports on, say, China’s increasing investments in coal, human rights violations in Xinjiang, frequent health and safety accidents, or poor governance structures. Looking at the Middle Kingdom through an ESG prism, it sounds like a no-brainer for any sustainable investor to just steer clear of the monster.

Yet, there is nothing trivial about this particular divestment decision. Opting to exclude China from their emerging Asia portfolio, AP3, for instance, soon found out that it wasn’t the popular choice they thought it would be, based on the running discourse. “As far as I am aware, no other large institution has moved forward and acted on this,” shares Claudia Stanghellini, Head of External Management at AP3. “There are not many such live strategies [Asia x China] in the market, either.”

KLP’s approach offers a possible explanation. “For any investor holding a reasonably diversified portfolio of assets like us, China is simply impossible to ignore,” reasons Arild Skedsmo, Senior Analyst – Responsible Investments at KLP Asset Management. “Even if we opted out of emerging markets altogether, once you consider the value chains of the companies in our portfolio, many of those inevitably lead us back to China.” So, KLP has decided to acknowledge the imperative of managing the portfolio’s exposure to China instead, and to engage with Chinese companies, focusing on the environmental and social aspects.

I won’t drag you down into that eternal ‘engagement vs. exclusion’ rabbit hole of a debate. Suffice it to say, that each approach has its merits and limitations. Whichever you choose, just make sure it is a conscious decision and be aware of the consequences.

May you be bold, fearless, and wise in your choices, dear reader, like the proverbial Dragon!

Image courtesy of NordSIP via Midjourney

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