Investors still bullish on Chinese surveillance stock despite human rights concerns

US lawmakers say that surveillance companies have won government contracts worth more than $1.2bn from the incarceration of Muslim minorities.

In early November, investors gathered at Claridge’s in London for a conference organised by Comgest, a “long-term buy & hold” equity investor. Stewardship is driven by rigorous coverage – each analyst is limited to a maximum of 10 stocks – and further enhanced by taking significant positions.

Each of the 967 mosques in a single county had facial recognition cameras at their entrances, says research

During the event, portfolio managers discussed an emerging market pick held by at least three Comgest funds, China’s largest CCTV maker, Hangzhou Hik-vision Digital Technology. With a stake valued north of $161m, Comgest is among the surveillance giant’s top 10 shareholders. Unconstrained security spending by the government had propelled share prices upward, producing a “very strong performance … over a multi-year time horizon”.

When asked about the risks of investing in state-backed surveillance programmes, Comgest Emerging Markets Portfolio Manager, David Raper, said that a higher discount rate was in place to reflect the risk of “social backlash”. However, investors were assured Hik-vision was in the business of “law and order, not oppression”, and “cultural differences” required sensitivity.

A few weeks later, a Uighur woman testified to US lawmakers about her experience being detained in one of the camps that now dot China’s western Xinjiang region. “Each time I was electrocuted my whole body would shake violently … I begged them to kill me,” said Mihrigul Tursun, describing torture in the “tiger chair”. She was reportedly detained three times before fleeing the country.

According to witness reports, inmates are made to memorise communist propaganda and phrases such as “I deserve punishment for not understanding that only President Xi Jinping and the Communist Party can help me”. Former inmates claim that they were forced to confess to being traitors, separatists and terrorists, and to forsake their faith: “There is no God. I don’t believe in God. I believe in the Communist Party.”

The UN estimates about 1 million ethnic Uighurs, a Muslim minority of Turkic heritage, are being held by Beijing in so-called ‘re-education camps’ as part of a crackdown on religious extremism in Xinjiang. A Reuters analysis of satellite imagery revealed 39 camps which have almost tripled in size since April 2017 and now cover an area equivalent to around 140 football fields. A sum total of 80 detention facilities have been identified.

Infrastructure of this scale is fertile ground for investment, and those who have capitalised have enjoyed healthy returns. IPVM, a surveillance research firm, estimates that in 2017, Hik-vision won $111m worth of contracts for the supply of “mass facial recognition system(s)” to camps and mosques in Xinjiang’s Moyu and Pishan counties.

China’s second biggest CCTV maker, Dahua Technology Co. Ltd., is also a beneficiary. A filing to the Shenzhen stock exchange in July 2017 announced a winning bid for a $685m project in Xinjiang’s Yarkant county. On this basis, a Deutsche Bank research note advised investors to “buy” the stock, estimating the project would “contribute to 4%/12% of revenue in 2017/2018, respectively”.

This inflow of technology has resulted in an extremely intrusive surveillance system in Xinjiang. Witnesses describe mandatory facial scans at petrol stations, the collection of residents’ biometric data and facial recognitions systems which track the movement of selected individuals. Each of the 967 mosques in a single county had facial recognition cameras at their entrances, and a minimum of five cameras, says research.

A report from Human Rights Watch alleges the existence of a “predictive policing system”, which aggregates Big Data to flag and detain individuals deemed “potentially threatening”.

The scale of Hikvision and Dahua’s role in the Xinjiang surveillance regime has been public knowledge for some time.In August, US lawmakers singled out the two companies for sanctions under the Magnitsky Act. In a letter addressed to the Trump administration, Hik-vision and Dahua Technology were said to have “assisted officials in the mass detentions and surveillance of ethnic minorities”.

In return, they “profited greatly from the surge in security spending, reportedly winning upwards of $1.2bn in government contracts for large-scale surveillance projects”. A subsequent bill introduced to the US Congress, the Uyghur Human Rights Policy Act of 2018, listed 12 Uighur Muslims who had died in custody, calling Xinjiang a “slow motion Tiananmen”.

Despite this, Hik-vision stock have remained attractive to foreign investors. At the time of publication, 14 of its top 20 fund holders were foreign-domiciled, with holdings worth approximately $1.3bn. These funds are run by American Funds (Europacific Growth A & VA CollegeAmerica New World – $427m), Carmignac (Patrimoine A & Investissement A – $262m), Aberdeen (Global China A & Emerging Markets Instl – $164m), Comgest (Emerging Markets & Magellan C – $121m), T. Rowe Price (Emerging Market Stock – $74m), Artisan Partners (Artisan Developing World – $70m), Harding Loevner (Institutional Emerging Markets & Emerging Markets Advisor – $94m), Schroder’s (ISF Asian Total Return – $43m) and Baron Funds (Emerging Markets Insitutional – $39m).

Foreign investors are less bullish on Dahua Technology, although Fidelity’s China Special Situations fund, the UK’s largest China investment trust, more than doubled its position in the company recently, to $13m.

The inclusion of both companies on the MSCI Emerging Markets Index has accelerated the inflow of foreign capital. The popular reference index is benchmarked against over $1.8trn in assets, and allocates a total weighting of 0.014% to Hik-vision and Dahua Technology. As a result, the Vanguard Emerging Markets Stock Index and the Fidelity Index Emerging Markets funds, for example, allocate $1.6m to both companies.

While US sanctions are yet to materialise, public mood is increasingly reflecting concern about the Uighurs, as details of their treatment continue to generate lurid headlines. But it remains to be seen whether the threat of reputational risk is sufficient to force a sell-off from investors already battle-hardened by a turbulent year.

Share prices for Hik-vision and Dahua Technology have plunged 31% and 43% respectively, year-to-date, due to the negative publicity from Xinjiang and an unrelated ban on the use of their products by US government agencies. The latter followed national security concerns after it was revealed that both companies were owned and controlled by the Chinese government.

International pressure over Xinjiang is unlikely to ease anytime soon and Hik-vision and Dahua Technology are seizing the initiative to placate investors.

According to Simon Rabinovitch, Asia Editor of the Economist publication, Hikvision representatives recently met concerned Western investors and responded to news of sanctions by saying that the company is already selling less in Xinjiang and could not control what customers did with its technology.

In a note to investors posted online, Dahua Technology affirmed its commitment to “the principle of neutrality of technology” and said that the proposed sanctions were one of many proposals submitted annually by the US Congress, of which only a few are adopted.

At least four investment managers with exposure to Hik-vision and Dahua Technology have A+ ratings in the PRI’s 2017 assessment of signatories: Comgest, Aberdeen, Fidelity and Schroder’s. It is worth noting that, in their submissions, Aberdeen, Fidelity and Schroder’s indicate that their investment policies were not developed in line with either the Universal Declaration of Human Rights, the UN Global Compact or the UN Guiding Principles on Business and Human Rights.

The PRI declined to comment on the implications of the surveillance sector for responsible investors.
There are signs that China’s crackdown is spreading to other states. A report in the Financial Times this week suggest that Ningxia, home to the largest concentration of the Huis – another Muslim ethnic minority – could be the next target of surveillance.

Subduing the Uighurs has become a multibillion-dollar national industry, seeded by foreign investment professionals. But their refusal to divest holdings, despite falling share prices and international outcry, suggests that the market expects the boom to continue.