By now, most investors have grown familiar with the idea that we’ve entered a noisy period of geopolitics.
Hong Kong has been caught up in the ongoing trade dispute between the US and China and protests have reignited over national security legislation proposed by the mainland. To add to this, President Trump’s administration has asserted a loss of autonomy in Hong Kong and threatened to revoke the city’s special trading status with the US.
We are likely to see more of these flashpoints and for investors, the increased volatility will spell greater uncertainty.
As long-term investors in the region, we have been watching the situation closely, acting prudently, and since the unrest started, have sensibly reduced our exposure to Hong Kong. We know that periods of turmoil ultimately pass and can often present opportunities.
Here’s how we see the current situation in Hong Kong and where we see opportunities emerging.
Recent developments involving the drafting of new national security laws and the establishment of Chinese security agencies in Hong Kong have raised concerns over its autonomy and the role of the Basic Law as the city is gradually being subsumed into mainland China.
The US has indicated that it could revoke special treatment and favourable trading terms currently afforded to Hong Kong.
These include suspending Hong Kong’s status as its own separate customs zone from the mainland and nullifying the free exchange between the US dollar and Hong Kong dollar.
While it is true that Hong Kong’s contribution to China’s GDP has declined over the years as China’s economy transitions from being a low-cost manufacturer of goods to a more developed service-based economy, Hong Kong still matters (a lot) to both China and the US.
As one of the world’s biggest hubs for international finance, Hong Kong is where global investors come to access China. Hong Kong remains one of the biggest markets for equity and debt financing and attracts the bulk of foreign direct investment in China. It represents a very important strategic gateway for Chinese companies to access a deeper and broader pool of foreign capital.
In 2019, the Hong Kong stock exchange raised HK$314.5 billion through 169 IPOs, making it the world’s largest listings market for the seventh time in 11 years. Hong Kong will likely remain the first choice for Chinese companies that would like to be listed on an international and world-class stock exchange.
Aside from Hong Kong’s port handling a large share of China’s exports and imports, the city is also China’s largest trade partner in services. In 2018 its market share of service exports represented over 20% (the US accounted for 17%).
Hong Kong is also important to the US in that any punitive measures implemented will likely harm US economic interests.
According to the American Chamber of Commerce, over 1,200 US companies conduct business in Hong Kong, of which over 800 are either regional offices or headquarters, while more than 80,000 US citizens live in the city.
Hong Kong is a significant trading partner for the US, having a trade surplus of over US$30 billion1 with the cumulative stock of US foreign direct investment exceeding US$80 billion.
Amidst the political bluster and soundbites, we should not lose sight of the idea that ties between the US and Hong Kong have been built up over many decades, are not easy or quick to unwind. There is a genuine disincentive to do so.
While uncertainty currently reigns over Hong Kong’s status as a global hub for finance and commerce, investors should not lose sight of the fact that most Hong Kong property companies have very strong balance sheets and have continued over the years to strengthen their recurrent incomes.
We continue to invest in Hong Kong businesses where we believe they can deliver the stable cashflows that supported our original investment case and have maintained our holdings in non-discretionary retail REITS such as Fortune REIT and Link REIT.
Since the unrest started, we have reduced our exposure to Hong Kong to 12.7% at the end of May, particularly in those sectors where we felt the risk was greatest, such as luxury retail and hotels.
In the immediate term, Hong Kong will likely face declining tenant demand and downward pressure on market rents and values across hotel and retail assets.
The longer-term case for our exposure to the market remains intact and we expect it to continue to underpin the regular income stream it has delivered to our investors over many years.
As long-term investors in the region, we remain focused on what we set out to deliver when we established the fund, a secure and stable monthly income through high quality commercial property.