According to a 2019 study1, investors believe that experienced investment teams and proven risk management capabilities are the most important attributes when choosing a China manager.
Yet while the world’s second-largest economy gives investors access to an immense opportunity set, the asset class is a highly volatile one, with heavy participation from less sophisticated retail investors. And although active manager outperformance from local managers based on the mainland is not rare, consistent, disciplined risk management is often found to be lacking.
We believe that being selective and carrying out in-depth due diligence and consistent risk management are key to navigating this dynamic market. Below are the key ways in which our commitment to risk management and our capabilities in this area are interwoven through our team and our investment process.
Industry insight
We lead with our depth and expertise in China and pan-Asia, plus our strengths in industry / ESG perspectives and risk management. Our 11-person team, based in Hong Kong, is comprised primarily of industry specialists responsible for driving research within China and across Asia Pacific. Having both China-dedicated specialists and regional industry experts provides insight to invest actively and for the long term in China equities.
Regional perspectives allow for an ‘outside in’ perspective on the dynamic changes in China, while on-the-ground insights are backed by frequent trips, meetings and site visits. Industry expertise allows for a clearer understanding of Environmental, Social and Governance (ESG) materiality and a lifecycle stage view of the business model, based on our learnings from other parts of Asia.
Risk aligned with fundamental stock conviction
Our high conviction portfolio benefits from rigorous company analysis, enabling us to carefully select long-term winning businesses in China, regardless of where they are listed. We focus on investing in companies with strong balance sheets, solid cash flows and relatively stable earnings.
We rely on alpha from bottom-up stock picking to drive the performance of our strategy. Our data shows that idiosyncratic risk has contributed approximately 60-80% of the portfolio’s total active risk since inception. We believe that our competitive advantage lies in our fundamental high conviction views on companies and industries.
Our portfolios are closely scrutinised using multiple risk models, such as Axioma, Bloomberg, UBS PAS, Citi GRAM, MSCI Barra and RBC e-Lab, to understand active risk and contribution to active risk from various perspectives and to avoid unintended style exposures.
We have a dedicated a dedicated portfolio engineer who leads the analytical work required, however as a team we have a strong culture of risk awareness.
We know our companies
Responsible investing is an important consideration that drives our strategy. Integrating ESG helps us to understand businesses from a long-term, broader perspective, which both formulates and challenges our views and convictions. With market information on company ESG factors still being limited in China, the engagement that we have with every business we invest in provides an additional layer of understanding around each company’s future direction and risks. We have an ‘ownership mindset’ and regularly and continuously engage with management to ensure that ESG risk is carefully considered.
Philosophically we focus on ESG in our process as a point of risk mitigation. We try to avoid management teams with the wrong incentive structures that may encourage unscrupulous practices that allow them to abdicate their broader responsibilities to both customers and employees.
Integrity of financial information
As with other emerging markets perhaps, China’s early growth stage economy makes it susceptible to corporate governance issues. Our fundamental investment process helps us find sustainable growth businesses that are attractive from a regional and sector specialist point of view. To complement our in-house process, we utilise third-party providers (such as forensic experts, GMT Research, to go through historical financial statements), proprietary quant tools, academic research-based quality screens and in-house audit/quant specialists.
We believe that it is our job to ensure the risks - from an ESG perspective - of every investment we make are researched in a disciplined manner and properly understood; this will help preserve capital and generate alpha over the longer term.
Strong parent company
As a team, we are steeped in a strong risk management culture, backed by a global financial institution, and this sets us apart. Being part of RBC is one of our strengths, giving us access to capital that allows us to invest in research and development, supporting the global growth of our organisation. This means that we can provide our investment teams with the talent, tools and resources they need to do their jobs well.
Our commitment to long-term active investment management is reinforced by our global presence, with diverse capabilities across disciplined and accountable specialist investment teams. Knowledge sharing and discussions within the firm give us an alternative perspective on China equity investing and add depth to our perspective on regional and global affairs.
The strength and stability that comes with being part of RBC GAM enable us to attract and retain top talent, invest in strategic shared resources, such as the Corporate Governance & Responsible Investment (CGRI) team and the RBC GAM Investment Strategy Committee (RISC), and exchange best practices, particularly on ESG integration and risk management.
Being part of RBC equips us better to deliver high quality investment and client service with a single-minded focus on clients, and allows us to create customised client solutions through our specialised investment teams supported by global resources.
Portfolio diversification
History has shown that Chinese equities appear to be less driven by global macroeconomic factors and are therefore less correlated to other global equity indices. Furthermore, idiosyncratic alpha opportunities in China make the country a more interesting market over the long term. This disruptive growth is best captured through an active manager that understands how China and Asia are changing.
With our fundamental-driven approach and on-the-ground perspectives, we are able to provide risk management and alpha generation opportunities, as we partner with clients that are calibrating their China equity allocation. Diversification helps investors to remain steadfast and fully invested for the long term, while managing volatility and risk within a disciplined framework.
Conclusion
China’s economy has been undergoing unprecedented change, and it remains an exciting investment proposition. We believe our fit-for-purpose risk management process enables us to manage China’s higher risk while deriving alpha predominantly from bottom-up stock picking. Risk management is integral to our investment process at every step – when conducting fundamental stock research, during portfolio construction and in post-investment risk monitoring.
We have always believed that effective risk management is key a differentiator in the China equity asset class and our track record of strong risk-adjusted returns is testament to how we have put this belief into practice.