Investors in China equities have been on a roller-coaster ride this year. The Shanghai market soared 60% to a seven-year high in mid-June and then tumbled 43% over the following two months to a trough reached on August 26th. Since then there have been periods of recovery followed by reversals. However, a number of recent developments have improved prospects going forward.
The overall slowdown in the Chinese economy is looking more moderate than many have feared. Third-quarter GDP growth was 6.9% year-on-year. The annual figure for 2015 is likely to be 6.8%. The government is guiding the economy through a major transition from a heavy emphasis on exports and industrial growth towards increased emphasis on domestic consumption, services, and movement up the value chain. The results are evident in the strong 8.6 annual growth in the services sector and accelerating retail sales fueled by robust wage growth. These factors account for the surprisingly strong GDP growth despite the manufacturing industry’s continued overall weakening and a sharp decline in fixed-asset investment. Both fiscal and monetary policy are said to be directed at assuring that growth is maintained close to the current rate and not less than the 6.5% officials say is needed. But an outcome closer to 6% looks likely in view of the headwinds still facing the economy, which include continued excess capacity, excess supply in the real estate sector, high corporate and local government debt burdens, and export weakness.
A positive development was the announcement by the International Monetary Fund (IMF) that its staff has concluded that China meets the requirements to have its currency, the yuan, added to the IMF’s Special Drawing Rights (SDR) basket, joining the dollar, yen, euro, and pound. In doing so, the IMF staff judged that the yuan is “freely usable” and that all the operational issues raised by the staff in July have been addressed. Final approval by the IMF board on November 30th is assured. The new SDR basket will come into effect next September. This action by the IMF means the yuan will have the elite status of a “reserve currency.” However, the yuan’s actual use as a reserve asset, now limited to an estimated 1% of total global reserves, is expected to increase only very gradually. The near-term effects will be the increased prestige and standing of the Chinese economy and the recognition that China has become more closely integrated into the global economy.
China’s capital outflows, which surged after China devalued its currency moderately in August, reversed in October, signaling some success in China’s efforts to restore investor confidence. The central bank reported an increase in foreign-exchange reserves. Another positive signal was the November 6th announcement by the China Securities and Regulatory Commission (CSRC) that it has lifted its four-month embargo on IPOs. This move appears to reflect Beijing’s growing confidence that markets may have finally stabilized after the government’s unprecedented –and in our view rather ham-fisted – rescue efforts in response to the market meltdown that started in early summer. Having taken this step, the CSRC is unlikely to extend its ban on stock sales by shareholders with more than 5% stakes beyond the ban’s scheduled January 8 end date. This evidence of CSRC confidence in the market’s stabilization is a positive consideration, which investors need to balance against the prospect of greater equity supply coming onto the market.
As the Chinese equity market seeks to recover in fits and starts from its August 26th trough, the major China ETFs are showing great diversity in performance. We will look at just the top ten, ranked by assets under management (AUM), of the 31 China ETFs available to US investors. TheiShares China Large-Cap (N:FXI), has by far the largest AUM, almost $6 billion, and includes only the 50 largest and most liquid Hong Kong-listed Chinese companies. It has declined 2.63% during the past month and is still down 8.14% for the year to date (YTD) through November 19th. The iShares MSCI China (N:MCHI), has the largest AUM among the total-market China ETFs, almost $2 billion. It holds so-called H-shares, P-chips, and red-chips of Chinese firms listed in Hong Kong but has not been able to hold N-shares listed in the US. This is about to change, as MSCI has announced that starting next month it will include companies in its indices according to the countries they operate in rather than just by the countries in which they are listed. In the case of the MSCI China ETF, this change means that at least 14 important, US-listed Chinese consumer and tech firms, including Alibaba (N:BABA) and Baidu Inc (O:BIDU), will be included in MCHI. This ETF is down 1.23% for the past month and 4.86% YTD. The SPDR S&P China (N:GXC), does include N-shares, and this structure is reflected in their better performance: up 2.28% over the past month but still down 2.67% YTD.
The PowerShares Golden Dragon China Port (N:PGJ), has a very different approach, as it holds only N-shares. This restriction to just companies listed in the US means that the four largest Chinese state-owned banks are not included and the ETF is heavily weighted towards consumer and tech companies. Its performance is also very different, up 10.96% over the past month and 13.46% YTD. Among the top ten Chinese ETFs, this performance is exceeded only by the KraneShares CSI China Internet (O:KWEB), the biggest China technology ETF, which selects holdings from all investable Chinese shares, including A-shares listed in the mainland China markets. It is up 12.52% over the past month and a remarkable 15.25% YTD. Note that KWEB does trade at wide spreads. Another alternative is the Guggenheim Invest China Small Cap (N:HAO), which is up 0.86% over the past month but down 0.96% YTD. Focusing on consumer cyclicals has produced somewhat better results: the Global X China Consumer (N:CHIQ), registered a 3.88% over the past month and is up 6.10% YTD.
For investors wishing to focus on the mainland China markets, the largest ETF that invests just in A-shares is the Deutsche X-trackers Harvest CSI 300 China A-Shares (N:ASHR). It is up 9.74% over the past month but just 2.07% YTD. But for investors that have held the ETF for 12 months, the return is 38.56%. That compares with a 12-month return for MCHI of a mere 0.12%. The other A-share ETC in the top ten is the Market Vectors ChinaAMC A-Share (N:PEK), which is up 11.25% over the past month and 4.61% YTD.