11 Observations on Asia

“It is better to travel 10,000 miles than to read 10,000 books.”

There is certainly some truth in this old Chinese proverb, especially when it comes to understanding China. Actually being there and seeing how things operate versus just reading about it makes a big difference. I just returned from my second trip to China (in addition to stops in Hong Kong and Singapore) and my eyes were opened even more.The reason for the trip was the semi-annual meeting of the Wigmore Association. Regular readers of this newsletter will remember that Wigmore is a global association of eight leading family offices from seven countries and four continents around the world. (We welcomed our newest member at our recent meeting, one of the leading multi-family offices from Mexico.) The group is composed of the Chief Investment Officers from each family office and meets to exchange views on the outlook for the global economy and markets, share insights on investment strategies and managers, and discuss best practices for serving wealthy families. Meetings have been held in London, New York, Melbourne, Toronto, Frankfurt, Rio de Janeiro, and Montana.This most recent trip took us (Northwood president Scott Hayman and me) to Beijing, Hong Kong and Singapore. We met with a remarkable array of government officials, regional experts and local practitioners. Our speakers and hosts included the following:

• A very senior official of the People’s Bank of China
• Senior Chinese government leaders in the areas of statistics, urbanization and environmental issues
• Chief economist for Asia of a major investment bank
• Asian fund managers managing equities, real estate, private equity and hedge funds
• Local entrepreneurs and business leaders in China, Hong Kong and Singapore
• Professors from world renowned Tsinghua University (Beijing) and Singapore Management University
• Members of wealthy families
• Leaders of Asian family offices
• Ex-pats and other long term Asia-watchers

I thought I would share some observations from our recent trip, which I have summarized into the 11 following points. I do so with great humility both because Asia hosts many ancient cultures which cannot be captured in a few sound bites, and because so many others know Asia much better than I do.

1. Not so different from us...

I got the sense that the Chinese government is really a massive corporation vs. primarily a political (ideological) entity. There was very little political rhetoric; rather the discussions seemed to be focused on how they are trying to solve incredibly complex engineering, societal, environmental and financial challenges. It sounded a lot like home. Senior government officials seemed open and candid, sometimes talking about mistakes that have been made and how they should to be corrected. People were friendlier than I thought and society seemed more progressive than the papers seem to suggest.

2. ...but in other ways, very different

There was much discussion with locals about Chinese culture. It was assumed that it is very different from the west and that it needed to be explained and properly understood. Democracy, such a visceral passion for many in the west, seems to be less important in China, especially in comparison to the desire for free commerce. We had interesting and open discussions about the need and desire for freedoms. The government blocks many websites, including Google (but not Yahoo, interestingly enough) and Facebook and some of the people we spoke to described this censorship in a positive light as the government’s role as a ‘parent’ taking care of its ‘children’. We were told numerous times that China has a very relationship-focused economy and not just about the numbers, and that Chinese culture is described as “head down, work hard, mind your own business, take care of family and friends, be self sufficient.” Several times we were reminded that China has always been inwardly focused i.e. not invaders or empire builders.

3. China is a big country

While this sounds positively tautological, it was mentioned to us by most Chinese we met with. China has a massive number of people which means a lot of consumers and a lot of traffic and pollution. But it also has many regions and there are major differences among them. For instance, the average GDP per capita of China is nearly US$8,000 (2/3 of South Korea and 20% of the US), but it is very low in the west and very high in the east. In other countries, when a slowdown happens or production costs go up, you move to another country. In China, you can move to another province.

4. Generally very positive on new the government vs. the previous administration

Almost everyone we spoke to was very positive on the new government of Xi Jingping. The politburo has been reduced from 9 to 7 people. They are also younger than the prior group and grew up with a more positive view of the new ‘economic openness’. Many of the leaders have practical experience running provinces or large cities. There seems to be good progress being made on the major issues facing the country. And Xi has begun a serious crackdown on corruption that seems to be having an impact.

5. They seem to have a good awareness and admission of their problems

There seemed to be a good assessment of risks and challenges they are facing as a society e.g. slums, pollution, corruption. They admitted to significant environmental problems and explained how they plan to go about solving them. They discussed the classic trade-offs, including the fact that cleaner natural gas is 30% more expensive than dirty coal. They talked about the need to raise fines on polluters because at the current low rates, it is cheaper for companies to simply pay the fines and keep polluting. They know they need to solve the massive traffic and urban livability issues and have some very specific plans to deal with it. They know they have transparency issues and are working to address them. They have immense traffic problems, especially in the larger cities. Beijing has 30 million people and 5.5 million cars. It took us an hour and a half to get to our hotel from the airport, which would otherwise be a 15-20 minute drive without traffic.

6. Growth is slowing, but most don’t expect a crash

Growth is definitely slowing from the 9.8% per year average since the start of the reforms. What it will slow to (7%, 6%, 5%?) is still anyone’s guess but slowing growth is normal at this stage of development (as has been the case in other recently developed economies). Due in part to the one child policy, the population will peak soon and the labour force peaked two years ago. Growth will ultimately be powered by continuing urbanization as over half of the country still lives in rural settings and many will migrate to the cities. This is how they expect the ‘ghost towns’ that dot the country will ultimately be filled up. This seems to be an example of how state planning got just a little bit ahead of itself, but the massive population shifts to come will ultimately solve the problems.

One interesting side note is that the anti-corruption drive is slowing economic growth over the short term. (Sales of moon cakes, a common ‘gift’ to grease the wheels of business, are down 50% this year.) Government crackdowns in jurisdictions without consistent rule of law can cause paralysis as people try to figure out what the true intent of the ‘new sheriff’ is. The consensus is that the anti- corruption focus will be positive over the long term. It is also important to remember the important role of the state in command economies and its role in creating cyclical swings. For instance, the previous government put home purchase restrictions in place in 2011/ 2012, so when they were removed in 2013 all the pent-up demand pushed new home sales up 50%, and then so far in 2014 they have fallen 10%.

7. Debt is rising, but most don’t expect a crisis

The Chinese government has significant debt, much of which has been accumulated over the past 6 years. It now stands at 200% of GDP, well above international medians. Many economists, while concerned, discount the probability of a China debt crisis because most ofthe debt is domestic and not owed to other countries. Foreign debt is $600 billion and foreign currency reserves are $4 trillion. Most of the government debt is held at the local level, which does raise some concerns. Corporate debt (private and state owned enterprises) is 115% of GDP but is also mostly domestic and companies have a lot of cash and good assets behind them. Household debt is low (20% of GDP) and mostly in the form of mortgages.

8. Things are changing

• We may have thought of China’s role is the world as a ‘factory’ in the past, but it is slowly shifting to a ‘consumer’ market which will buy the world’s goods.
• Internally, it is also shifting from a manufacturing economy to a service economy, which will have a significant impact on the labour market.
• Much of the local government debt is being collateralized so the switch from bank debt to bonds will increase transparency.
• The government is making changes to the education system to boost independent thinking vs. traditional memorization and rote learning.
• There seems to be an increased focus on initiating some property and intellectual property rights. China’s patents per capita are about one tenth of South Korea’s and one third of the US, and they want to see them grow.
• There is a shift to private companies from state owned enterprises (SOEs) and mixed ownership based on the substantially higher productivity of the private ventures. (But this will be a very long process given that there are over 100,000 SOEs.)
• Increasingly, political success is being judged, not just by GDP, but also based on quality of life of the citizenry. In fact, government seems to gradually be viewing the people as ‘clients’ of the government.

9. Wealth management in China

Wealth management is underdeveloped in China but it seems to be growing quickly to keep up with the substantial new wealth that is being developed. There are not many investment options available so people default to the ones they know and can access. Property often fits the bill and has turned into bubbles because of it. People seem to use property as a store of value (almost like gold) and care less about renting it out. Stock markets are becoming somewhat more developed and expanded and there is the expectation that Chinese people will ultimately be able to buy foreign securities. The general consensus is that much of the seriously large wealth is being quietly shipped out of the country through illegal means.We had meetings with the resident wealth management and family office specialist at the world-renowned Tsinghua University in Beijing where they have developed global partnerships to meet the growing demand for wealth management and education in China. We delivered a lecture on our book, Family Wealth Management, to the Canadian Chamber of Commerce in Hong Kong. And we presented to the Business Families Institute at the Singapore Management University and expect to do further collaborative work with them both from a Northwood standpoint and in my role with the Rotman School of Management at the University of Toronto.

10. Hong Kong is skeptical

Following a productive visit to China and a general sense of progressive movement there, we arrived in Hong Kong and were met with a chorus of China detractors. Many of the people we met told stories of the risks of working and doing business in China. The lack of property rights and rule of law means that it is very important to watch your business interests very carefully and to find trusted locals who know the ropes. Hong Kong is also experiencing major air quality issues as many factories (both in southern China and in Hong Kong itself) spew foul chemicals. It has become a major lifestyle issue in Hong Kong. The recent demonstrations in Hong Kong echo the comments from long time Hong Kong residents about what they referred to as the ‘Chinese creep’ as Beijing continues to integrate themselves into day to day Hong Kong life.

11. Singapore is humming

If mainland China is the ‘wild west’ in terms of transacting business, Singapore is the opposite. It is regulated, there is rule of law, there is transparency, and there are serious consequences for misbehaving.There is significant state control but it seems to be behind the scenes and the island of 5 million people runs extremely efficiently. When traffic congestion started to develop several years ago, the government put in toll roads, built expressways and required drivers to buy a permit every ten years for USD$60,000. We had no traffic issues! Among many other meetings, we met with the Monetary Authority of Singapore who made it clear that they are proactive regulators but are also working hard to make Singapore an attractive place to do business and manage money. Many excellent global money managers are now located in Singapore and Singapore is probably a pretty good place from which to venture into investments in the rest of Asia. We held our Wigmore Association meetings in Singapore and had an extremely useful dialogue among the members, exchanging investment approaches, contacts and best practices. This collaboration is an extremely valuable process and helps to make us wiser managers of wealth and better advisors for the families we serve.Overall this was an extremely enlightening trip and I look forward to the next one.