The Canadian Pension Plan Investment Board (CPPIB) reports assets of $400 Billion at March 31, 2020. 4% is invested in companies that are under the influence of the CCP1. The Board expects to grow that to 25% by 2025.
A Public Pension plan investing employee’s pension funds as a fiduciary should be more limited in the risks that they can expose the fund to. If the risk of investing in a certain country is seen to be increasing, the allocation to those investments should, ceteris paribus, decrease, unless higher return expectations are seen to justify the increased allocation.
Many funds (not all) also apply another screen to their investments – Socially Responsible Investing – which excludes investment in themes such as tobacco; oil & gas; countries with known human rights abuses, etc.
The risks of investing in CCP-controlled China are increasing. Here are some of the main risk:
• Sanctions risk. Relations between the CCP and the US (its biggest trading partner) are deteriorating. As a result of the CCP delaying the release of, and hiding information about, the Wuhan-virus, and their unlawful violation of the Basic Law of Hong Kong, the US is stepping up sanctions on the regime.
• Risk of worsening International relations. Other countries are joining this chorus of complaints against the CCP’s heavy-handed tactics. Nine countries recently formed the “Inter-Parliamentary Alliance on China” (IPAC) to “adopt a tougher stance on the CCP”. This in response to the CCP’s increasing lawlessness and threats when questioned.
• Trade risk. As the CCP shows no signs of contrition and sanctions increase, trade and exports will suffer.
• Repatriation risk. Many foreign companies operating in China are moving their operations out of the country. This results in a drag on economic growth, reduces exports and depletes foreign currency reserves.
• Capital control risk. To slow the depreciation of the RMB the CCP restricts the conversion of the RMB to USD making it difficult for foreign firms and individuals to move profits out of the country.
• Bank-debt risk. Many Chinese Banks have already faced failures, bank runs, or have needed capital infusions to survive. As the Wuhan virus crippled the economy, overdue loans are adding to the weakness of Bank balance sheets.
• Disclosure risk. Chinese Law prohibits any oversight by a foreign entity of the reporting that Chinese Companies produce (which has recently led the US to consider delisting companies if they do not comply with US reporting requirements). An investor in CCP-influenced companies like the CPPIB would be unable to fully analyze the financial position of their investment.
• Foreign exchange risk. The RMB is not a free-floating currency. The RMB is artificially maintained at a level above where it would be if free-floating. If this artificial peg were to fail (due to the Chinese Central Banks’ inability to continue to infuse liquidity) then the value of shareholdings in Chinese companies could fall dramatically.
To justify a planned 21% increase in exposure to companies influenced by the CCP the CPPIB must have a very positive outlook on most of these risks. Based on the companies that the CPPIB has invested in (Alibaba, Tencent, WeChat, to name a few) they appear also to have no qualms about investing in Companies which are known to be influenced by the CCP and who are assisting the regime with censorship, surveillance and facilitating human right abuses in mainland China & Hong Kong. Through these CPPIB Investments, Canadians are, in effect, subsidizing these abuses.
Is the planned increase in the portfolio allocation to companies tied to the CCP prudent given the higher risk – I would suggest not. The probability of large losses in a portfolio with exposure to companies influenced by the CCP is high given the risks outlined above. Losses in the Canada Pension Plan could directly affect the ability of the Plan to make payments to Canadian retirees. How would the Canadian public feel about this if they knew? Recent polls indicate that only 14%2 of Canadians have a favorable opinion of the CCP.
Some market commentators, notably Kyle Bass of Hayman Capital Management are very bearish on China under CCP leadership. One of the issues he highlights is the dismal state of the balance sheets of the Banks. The magnitude of bad loans is epic and it is only through the continual addition of liquidity, and the fact that the Renminbi is not free-floating, that Bank failures are being prevented.
• All figures from Epoch Times article “Canadian Pension money keeps pouring into China as risk escalate”, June 3rd, 2020.
• From Angus Reid “85% of Canadians say Chinese government has not been honest or transparent about pandemic”, May 13th, 2020.