Chinese equities have attracted attention following a government stimulus effort. An earlier drive to boost dividends and shareholder-friendly corporate policy failed to spark interest. However, direct aid ignited a sudden, large rally that has since fizzled. Still, investors poured $5.44 billion into a variety of emerging market ETFs in the week ended October 11, with $5.15 billion of that flowing to Chinese ETFs.
From what Chinese officials have said, they will do what it takes to hit their 5 percent GDP growth target. They believe a small, targeted stimulus should achieve that end. In light of this reality, are Chinese stocks worth chasing? Perhaps not for a hot money rally, but Chinese equities are relatively cheap after being in a bear market for nearly a decade.
For investors interested in exposure, there are many options available. When it comes to ETF coverage, China is one of the most well-covered foreign markets. There are dozens of ETFs covering the market. There are also several large liquid funds covering various market slices.
China’s stock market is different from most foreign markets because the domestic market isn’t completely open to foreigners. The domestic A-share market sits behind China’s closed capital account. At times, the A-share market can be totally divorced from Hong Kong and the overseas-listed stocks such as Alibaba (BABA) that many investors are familiar with.
In short, if you’re betting on the Chinese government boosting its own stock market, its locally traded shares are going to be the main recipients of this aid. Xtrackers Harvest CSI 300 China A-Shares (ASHR) is the largest ETF covering A-shares. iShares MSCI China A (CNYA) is a similar fund but is about one-tenth the size.
Hong Kong-listed shares, called H-shares, are the preferred avenue for China exposure for most investors. iShares China Large Cap (FXI) is the largest China ETF on the market, with $10.8 billion in assets. It’s also largely a proxy for Chinese tech stocks such as Meituan, Alibaba, Tencent, Xiaomi and JD.com. iShares MSCI China (MCHI) has similar companies in its fund, but has far more allocation to the top holdings, making it less diversified.
FXI offers broad coverage of all of China. ASHR has very different exposure because it doesn’t hold any stocks not listed in the mainland. The top stock is liquor giant Kweichow Moutai. The second-largest company is an EV battery maker, CATL. This is unique exposure compared with FXI and most broad Chinese ETFs that overweight tech stocks and Chinese banks. ASHR is far more exposed to value sectors such as consumer staples and industrials. FXI has 37 percent in consumer cyclical stocks. It has almost no real estate, consumer staples, basic materials, industrials, utilities or healthcare exposure. For that, investors have to go with the A-shares fund.
For smaller stocks, the VanEck ChiNext ETF (CNXT) covers the ChiNext Index of smaller growth companies. CNXT is a small fund at the moment, only $55 million, because of the long bear market in China. From the September 24 policy announcement to the peak of the rally on October 7, ASHR gained 53 percent and CNXT 118 percent. CNXT is dominated by its 41 percent weighting in industrials, 21 percent in technology and 18 percent in healthcare. If you want to buy the future of China’s domestic economy and can handle the roller-coaster ride, this is the fund to choose.
Another option is Xtrackers Harvest CSI 500 China A-Shares Small Cap (ASHS). Again, a unique fund, with 21 percent in industrials, 19 percent in technology, 17 percent in basic materials and 10 percent in healthcare.
For small-cap exposure via Hong Kong, there is iShares MSCI China Small-Cap (ECNS). The holdings and sector exposure are unique with 22 percent in healthcare, 13 percent in industrials, 12 percent in real estate and 12 percent in technology.
For investors who want tech exposure, there are two alternatives worth considering. KraneShares CSI China Internet (KWEB) is the larger fund, with $7.6 billion in assets. Invesco China Technology (CQQQ) is the older fund, but it has only $800 million in assets. Both funds offer similar exposure.
For alternative exposure, there is WisdomTree China ex-State-Owned Enterprises (CXSE). This fund has similar exposure to FXI, but differs in that it does not hold state-owned banks. The firms in this fund are all private. Smaller companies make it into the mix. The fund has CATL in its top-10 holdings.
For an ADR fund, there is Invesco Golden Dragon (PGJ). All holdings trade on the U.S. market, with top holdings including JD.com, Alibaba, Yum China and Trip.com. Consumer cyclical stocks are 50 percent of the fund.
If you want active management, Matthews China Active (MCH) is an option. Despite being actively managed, the 0.65 percent expense ratio is on par with most of the other ETFs on the market. Matthews has extensive experience with Asia-focused funds. During the rally, MCH performed on par with ASHR.
Beyond mainland China, there’s also iShares MSCI Hong Kong (EWH), which currently sports a yield of 4 percent. Financial services dominate with 47 percent of assets, followed by 18 percent in real estate, 15 percent in industrials and 10 percent in utilities.
What is the best choice?
For investors who want exposure to China in the broadest sense of the term, FXI is the go-to fund. It might change at some point, but even when the Chinese government announces domestic stimulus, foreign investors buy FXI first.
For those who want exposure to mainland China and any stimulus programs that might be aimed at the domestic market, ASHR is the top fund for exposure.
For those who seek the highest possible risk in a long-only stock fund, CNXT offers the highest volatility exposure. China still has the second-largest stock market in the world, and speculators there gravitate toward the ChiNext Index.
The tech funds offer exposure similar to that of FXI but with the tech exposure dialed all the way up. KWEB is the larger and more liquid fund and is the best option for now.
Outlook
A typical sequence of events often plays out in China. It announces plans for stimulus, investors go wild with speculation, and then the government disappoints. Ever since the government launched a massive stimulus in response to the 2008 financial crisis, China has consistently said it wouldn’t repeat that mistake. Even in 2020 when the Chinese government locked the economy down, it did not launch a major stimulus. In contrast, other governments including the United States have repeatedly made use of central bank quantitative easing along with high levels of deficit spending.
China has said its policy is to provide stimulus to ensure a 5 percent GDP growth rate. Currently, a Reuters poll of economists puts the expected growth rate at 4.8 percent. The amount of stimulus required to hit the government’s target is far less than many assumed.
That said, Chinese equities are relatively cheap compared with global markets. Chinese tech stocks are cheaper than U.S. tech stocks by a wide margin. China’s A-share market is cheaper than the S&P 500 Index. At some point, the Chinese market will recover even without stimulus.
Since peaking on October 7, Chinese markets have reversed, partly because of the bubbly move up and partly because the stimulus disappointed. Most China funds are still up about 10 to 20 percent since the first policy announcement on September 24, and CNXT is still up 34 percent, all as of October 15. A full reversal of the rally still leaves about 10 to 25 percent downside for funds.
Investors with long-term horizons should be cautious when buying around these types of speculative bursts. China engineered a bubble in 2014 and 2015 when the economy slowed. That eventually blew up and set off what is now a nearly 10-year bear market. Before the recent rally, the Shanghai Composite Index was still down nearly 50 percent from its peak in 2015. The old adage applies: buy low and sell high. We do not expect the government will change its mind on stimulus. Investors should expect China will be at the mercy of the global economy, with strength lifting exports and weakness helping keep the pressure on the indebted domestic economy.
In the long term, patient accumulation of emerging markets broadly speaking, along with China, appears the best course of action until there’s a clear signal that the global economy is heating up or capital is flowing out of the U.S. With the dollar rallying, oil down and Chinese credit growth still low by historical standards, the trend has not yet shifted into a configuration that argues for emerging markets, or Chinese stocks, being on the upside.
