FARGO — North Dakota pension and investment funds have significant holdings in Chinese companies as benchmarks that guide investments have dramatically increased their exposure to firms in the world’s second-largest economy.
The state’s investment chief estimates that $240.7 million of the $16 billion in pension and other investment funds his office manages are invested in Chinese firms as part of portfolios focused on growth-oriented, emerging market funds.
“We have no dedicated strategy to invest in China,” said David Hunter, executive director and chief investment officer for the North Dakota Retirement and Investment Office. He acknowledged, however, that investing in emerging markets index funds include stakes in Chinese companies.
North Dakota’s investment in Chinese interests is common as U.S. investors in recent years have poured hundreds of billions of dollars into companies in China — as well as domestic or multinational companies with significant involvement in China.
The flood of U.S. money into China, which has happened despite the festering trade war and increased friction between the two rival nations, is causing increasing alarm in Washington for a variety of reasons:
Investors could unknowingly be at significant risk. China lacks accounting and transparency requirements for publicly traded companies that are mandated in the U.S. and most other developed countries, making it easier to commit business fraud.
Investments in China can raise security concerns. Money in some Chinese companies is funneled to the People’s Liberation Army, which owns or is actively involved in many companies.
Some Chinese companies make monitoring devices that are used in suppressing ethnic and religious minorities, masses of whom have been herded into detention camps, raising human rights concerns.
Yet many people have no idea that, through their contributions to pension funds or retirement accounts, they could be helping to pay for actions they don’t support or find concerning, said Sen. Kevin Cramer, R-N.D.
The investment spigot to China has been opened in recent years as providers of investment indexes, which provide benchmarks that guide investment decisions for both institutional and individual investors, have increased their listings of Chinese companies.
“It’s on the rise,” said Cramer, a member of the Senate Banking Committee. “It’s the trajectory that’s scary” and “potentially a problem.”
Last year, for instance, almost $400 billion in new foreign investment in Chinese stocks was driven by changes in the allocations within these benchmark indexes — and American investors accounted for more than a third of that massive infusion, according to Steven Schoenfeld, the founder and chief investment officer of BlueStar Indexes, which manages a family of global indexes covering emerging markets and global technology.
The influx began in the middle of the last decade, before the trade war with China, when China already was the largest component of major emerging market indexes, Schoenfeld wrote in January in Foreign Policy. Beijing steadily eased restrictions on foreign investment, and the major indexes began to include more Chinese companies in their benchmarks, steering investments to China.
Congress has taken notice and is beginning to act, Cramer said. In May, by unanimous consent, the Senate passed the Holding Foreign Companies Accountable Act, which he co-sponsored.
One accountability problem the bill seeks to address is China’s refusal to allow a watchdog group, the Public Company Accounting Oversight Board, to audit Chinese companies. Securities issuers would have to disclose that inability — and, if the board is unable to inspect the securities issuer’s public accounting firm for three consecutive years, the issuer’s securities are banned from trading on U.S. exchanges. The bill awaits action in the House.
The legislation is aimed at protecting U.S. investors from fraudulent schemes by Chinese companies in situations such as one that came to light earlier this year involving Luckin Coffee, once a darling of Wall Street.
The Chinese company had aggressive growth plans to compete head-to-head with Starbucks and once was valued at $12.7 billion. But then it disclosed massive accounting fraud in April, including $310 million in fabricated sales, and the company’s value plunged.
The company was listed on the NASDAQ U.S. stock trading exchange, where domestic companies must meet stringent oversight and reporting requirements.
“It’s been an escalating concern,” Cramer said, referring to the wide range of issues arising from growing U.S. investment in China. There is broad bipartisan support for taking action to force China to be more transparent with financial disclosures of its companies and to curb human rights abuses through economic sanctions, he said.
“There’s not just bipartisan but really a unanimous concern about China’s growing influence,” Cramer said.
The Trump administration has been sounding alarms about U.S. investment in China, citing both the risks to investors and human rights concerns.
“It is both wrong and dangerous for China to benefit from our capital markets without complying with critical protections that investors in those markets rightfully expect and deserve,” a White House memo last month advised treasury, economic policy and national security officials.
“China’s actions to thwart our transparency laws raise significant risks for investors,” the memo continued. “The time has come to take firm action in an orderly fashion to put an end to the practice that has tacitly permitted companies with significant Chinese operations to flout protections United States law requires for investors in United States markets.”
In May, the White House pressed the independent board that administers the $40 billion international fund for the Thrift Savings Plan, the retirement system for federal employees and the military, to freeze plans to allow investments in Chinese companies that the administration suspects abuse human rights or threaten national security.
In response, the U.S. Department of Labor, which regulates the federal retirement system, agreed to put the plans on hold. Earlier this week, on July 1, the State Department posted an advisory for U.S. businesses alerting them to the possible moral and human rights consequences of investing in China.
The MSCI Emerging Markets Index, which guides more than $1.7 trillion in investments in 26 developing countries, greatly increased its inclusion of Chinese stocks late last year, increasing China’s total weight to 33% of the index — which Schoenfeld said was an unprecedented allocation within a single country.
North Dakota’s pension pool uses the MSCI Emerging Markets Index as a benchmark, and invests in funds that track or mirror the index, Hunter said.
Emerging markets funds generally provide higher growth, important for pension funds and investments like North Dakota’s Legacy Fund, which have a goal of earning 6% or 7% per year, Hunter said.
The pension funds for public employees and public school teachers, which together total $6 billion, and the $7 billion, together comprising $13 billion of the state’s $16 billion investment portfolio, with the rest largely insurance funds.
“Most folks would say you probably have to invest in emerging market equities, which would include China,” he said.
A final accounting of North Dakota investments in funds investing in Chinese companies was not available at press time. A preliminary estimate of Chinese investments indicates pension funds hold $123.8 million, the Legacy Fund $109.9 million and insurance funds $16 million.
North Dakota’s investment portfolios are managed by private investment advisers in consultation with the investment office and board, which evaluate performance, a process that evolves with developments in the market, Hunter said.
"As things develop we continue to re-analyze,” he said. The advisers guiding the state’s investments must follow prudent investor and fiduciary responsibility rules and most are signatories of the United Nations Principles for Responsible Investment, he added.
The exposure of state investment funds to China is something the investment office will take into consideration, along with many other factors, as it continues to evaluate its holdings, Hunter said.