As the world revisits decades of globalization and diminishes the interdependence and integration of the world’s economies, and as interests of China and its allies become less aligned with the interests of the U.S., Europe and their blocs, many institutional investors are caught between generating alpha and legislators who want their states’ funds to be completely divested from the world’s second-largest economy.

Geopolitical worries have led legislators in several states to mandate that their state pension funds divest from Chinese investments, considering that a potential conflict between the U.S. and China would lead to severe losses for American investors.

According to Future Union, a nonprofit which tracks institutional investments in China from U.S. state, county and municipal pension funds, endowments and foundations, U.S. public pension funds have invested more than $68 billion in China and Hong Kong over the 36 months prior to the end of June 2023.

Approximately 29 of the 74 largest U.S. funds tracked by Future Union made investments in China in the 12 months prior to June 30, 2023, and in the prior 36-month period.

Pensions Divesting From China

To date, several states have passed legislation to divest their assets from Chinese investments: Florida, Indiana, Kansas, and Missouri. Legislation has been proposed in several other states.

The Indiana Public Retirement System had divested $486 million of its $1.2 billion exposure to China, as of March 2023. The fund shed its full exposure to China in July.

“[The] INPRS has reinvested funds in a manner that keeps us compliant with our legal restraints and board-approved strategic asset allocation guidelines, which are designed to maintain an appropriate level of geographic diversity to meet the system’s risk and return objectives,” a spokesperson for INPRS said via email.

Some pension funds have removed China from their benchmarks, such as the Teacher Retirement System of Texas, which switched its equities benchmark from the MSCI ACWI Investable Market Index to the MSCI ACWI IMI ex-China/Hong Kong Index.

In May, Florida Governor Ron DeSantis signed HB 7071, which mandates the state’s pension funds to divest their directly held Chinese assets by September 2025. The State Board of Administration, which manages the Florida Retirement System, is expected to develop a divestment plan by the end of the month. The legislation does not apply to private equity or mutual fund holdings.

In December 2023, the board of the Missouri State Employees’ Retirement System voted to divest the fund of its Chinese investments over 12 months.

Lawmakers in several states, including Pennsylvania, have introduced similar legislation to order their pension funds to divest from China and other countries deemed adversarial. In April, a similar bill was vetoed by Arizona Governor Katie Hobbs.

But not all legislation is alike; some states’ bills and laws are less specific and demanding on divestment requirements.

“Some [legislation is] more stringent than others,” says Andrew King, Future Union’s founder and the general partner in venture capital firm Bastille Ventures. “Others are, ‘Hey, we’ll review in a year, set up a commission which doesn’t actually say anything about completely divesting.’ If you look at language in the bills, there [are still loopholes here] that can be used for grandstanding to say that we did this, but on the other hand, it may not come to fruition.”

This month, the U.S. House of Representatives is expected to hold a “China Week,” according to a source familiar with congressional plans. The effort is expected to focus on building bipartisan consensus on how to respond to trade and geopolitical threats from China. House Republican leadership is expected to introduce legislation on different China-related topics; while divestment legislation will likely not be on the agenda, it could be an issue addressed by the House in 2025.

“It is a challenging issue to conjure enough votes and thread the needle on as many legislators have [major] financial firms in their districts,” the source says, on the immediacy of any potential federal legislation regarding divestments.

Do Allocators Really Want to Divest From China?

For allocators, the need to fulfil their fiduciary duty, to invest in order to provide pension benefits to their beneficiaries, might conflict with the political or national security issues raised by those that favor divestment.

According to Future Union’s “Rubicon Report,” released in January, numerous investment firms with Chinese and U.S. operations have seen their China-based funds outperform their U.S. counterparts.
“There is interest in divestment, but it is a hot potato,” says King, who has been working with several f pension funds to make the divestment issue more palatable, while saying a number of LPs quietly want to increase their investments in China.

Representatives of two of the largest allocators to Chinese investments, the California State Teachers’ Retirement System and the California Public Employees’ Retirement System, told CIO in December 2023 that while their respective funds are invested in China, they are cautious with their investments.

“CalPERS is a global investor and believes diversification is a key component to generating the returns needed to meet the retirement security of our 2 million members,” a CalPERS spokesperson said at the time. “We are closely monitoring discussions in Washington and elsewhere and, as always, will comply with any additional government requirements that might be initiated.”

A CalSTRS spokesperson said the fund was decreasing its exposure to Chinese equities and would hire dedicated China managers to navigate risks. “Though China is part of the global market index and is the second-largest economy in the world, our exposure is modest and fell to No. 14 on our rankings of total fund exposures by parent country, as of February 2023,” the spokesperson said.

Read more @ai-cio.