The White House under the direction of President Trump made its move official yesterday — the international equity portfolio used by retired military personnel should not be investing in any Chinese stocks.
Period. A note warning about mainland China investing was sent to Labor Secretary Eugene Scalia on Monday and signed by National Economic Council director Larry Kudlow and National Security Advisor Robert O’Brien.
The $50 billion pension fund, known as the I-Fund, is currently indexed to the MSCI EAFE, which invests in companies from Europe, Australia and the Far East, namely Japan.
Changes were in place to switch out of EAFE and capture a more global index, this time the All Country World Index (ACWI). Some 4.5% is weighted towards China stocks listed in Shanghai and Shenzhen.
Trump hinted on May 1 that he would sign an executive order banning public employees from investing in China through the I-Fund, in particular. The I-Fund is part of the Thrift Savings Plan, the $558 billion federal employee retirement program.
The issue of the I-Fund was first brought up by Florida Senator Marco Rubio and New Hampshire Senator Jeanne Shaheen last year, warning the Thrift Savings Investment Board from changing its index. The change was recommended by financial consulting firms and some Wall Street heavyweights. But Thrift largely ignored Rubio and Shaheen and all paths led to the new index starting in June.
The letter to Scalia asks the Thrift Savings Investment Board to cease any scheduled plans to move money out of the MSCI EAFE and into the ACWI, and asked for the Board to respond to the request by Friday regarding their decision.
It is unclear if Trump can, or will, use an executive order to stop the I-Fund from switching indexes should the Board decide to go against the White Houses’ wishes.
The main complaints about investing in shares of mainland Chinese equities, of which most in the index are benign, stem from securities fraud, accounting practices that do not follow the same accounting rules for publicly listed companies that others in the index follow, and the fact that at least three names on the index have either been sanctioned by the U.S. or are currently sanctioned.
The letter did not single out any particular company, but one of the most discussed entities in that index is Hikvision, a partial-state owned security systems firm that has its surveillance cameras installed on facilities holding Uygher Muslims in what Beijing refers to as “re-education camps”. Hikvision is considered by Washington to be a human rights violator.
The iShares MSCI ACWI exchange traded fund, run by BlackRock, owns over 1.2 million shares of Hikvision.
Passive funds tracking that index would hold Hikvision, too. But actively managed funds tracking it could avoid it all together. It is unclear by the letter if the I-Fund would invest passively or actively in a fund tracking the ACWI.
In the letter, Kudlow and O’Brien said that if the I-Fund wanted more international exposure to emerging markets, there were other MSCI indexes that could give them that exposure. They mentioned the MSCI Emerging Markets Ex-China Index.
The MSCI EAFE is not totally absent China. It has a 3.7% weighting to Hong Kong, and includes multinational China companies like the well-known cancer drug developer BeiGene (BGNE), traded on the Nasdaq.
Companies listed in mainland China, known as the A-shares, are the ones drawing the most attention by Wall Street…and Washington.
The concern with the A-shares is the lack of financial audits and the threat of investing in sanctioned entities.
Luckin’ Coffee (LK) was also traded on the Nasdaq and was suspended from trading due to accounting fraud allegations first reported by investment research firm Muddy Waters.
According to Bloomberg, Scalia delivered the letter to Thrift Investment Board chairman Michael Kennedy yesterday.
If the Board agrees to not go through with the index change, it could be viewed as a headwind for China.
It opens the door for Washington to target securities investment as a new type of leverage in trade negotiations designed to get China in line with Western norms.
As it stands, Chinese firms do not lose anything from the decision. If the request is carried through, it is not a divestment from A-share equities as the I-Fund currently has no investments in mainland China listed entities.