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China: Is There Alpha?

Posted by Dan Weiskopf, ETF Professor on Jul 14, 2021 9:30:00 AM
Dan Weiskopf, ETF Professor
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Investors would be wrong in thinking that investing in China had been unprofitable over this past year. Similarly, we believe that avoiding China in the future would be a mistake. To that point, we uncovered some eye-opening details last week during some ETF Think Tank calls. We believe these are worth highlighting:

  1. Setting the Table: There are 47 ETFs, worth about $37.6 billion, that provide targeted access to China. Capturing the global economic growth benefits that will come out of China may take a targeted approach, but the China growth story is too important to ignore in a portfolio.
  2. Regardless of your political stance, China is a growth story, and a focus on technology and the consumer is imperative. Surprise! Healthcare through the KraneShares MSCI All China Health Care ETF (KURE) and the KraneShares MSCI China Clean Technology ETF (KGRN) have proven to be surprise winners, up 26.56% and 75.81%, respectively.
  3. Buying the China growth story when it is out of favor, although cheap in our opinion, takes bravery. However, the momentum is there. China leadership is not irrational and will not benefit by isolating itself economically.

Augment Your Broad Allocations with Targeted China Exposure

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There are 47[i] ETFs, worth about $37.6 billion, that provide targeted access to China, but the dollar amount is far greater when an investor considers allocating to certain International or Emerging market funds. Capturing the global economic growth benefits that will come out of China may take a very targeted approach. Examples of international funds that hold over-weighted positions in China include Davis Select International ETF (DINT) at 34%, and the Emerging Markets Internet and Ecommerce ETF (EMQQ) at about 59.15%. The broadest emerging markets funds, like the iShares Core MSCI Emerging Markets ETF (IEMG) and Vanguard FTSE Emerging Markets ETF (VMO), have about 47-48% weightings (including Taiwan and Hong Kong). But, as most ETF Nerds know, these funds are engulfed in state owned bureaucratic value traps. This can be illustrated simply when you compare the performance and holdings of the WisdomTree China ex-State-Owned Enterprises Fund (CXSE) and consider tactical opportunities in your allocation. As an extreme example, KraneShares MSCI China Clean Technology Fund (KGRN) has proven to be a surprise winner, up 75.81% over this past year ending July 9, 2021. We find it funny that, given the media headlines, a U.S. investor would have to assume that clean energy opportunities wouldn’t exist in China.

To highlight this point, below is our overlapping analysis on IEMG using our ETF Think Tank tools. To get into further details, we suggest financial advisors drill deeper by using the ETF Think Tank Tools, which are free to members, or sign up for premium membership and learn what ETF Action shows, and/or ETF Research. A premium membership does not require any cash outlay, but a shared due diligence experience which we believe increases awareness about how structure matters.

[i] Source: ETF Think Tank data base. 47 ETFs include leveraged, inverse and bond Exchange Traded Products, but do not include non-targeted ETFS that hold China exposure.

 

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Investors in Earnings and PEG Ratios Must be Excited

Growth is on sale, and certain investors are grabbing the opportunity. This can be illustrated in the chart that shows how KraneShares CSI China Internet ETF (KWEB) has been hammered by the underperformance of some of its top names (Tencent Holdings and Alibaba Group Holdings) versus the iShares Core MSCI Emerging Markets ETF (IEMG). However, note that the trailing Price Earnings Ratio is only about 22x, and the forward PE multiple is 24x; below the 27.36 avg and below 1 using current estimate levels. The PEG ratio for comparable US companies is about 2X, and this is despite having a total addressable market that is much smaller (See image and chart in the beginning).

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None of this is going unnoticed. The share count of KWEB has increased from 46.1 million to 68.4 million, YTD as of July 8, 2021. Clearly, institutions are embracing this $4 billion ETF and the high active share it brings to a portfolio.

China Isolationism

We do not wish to take a political stance in this report. Our motivation is simply to state what is perhaps obvious. The Chinese government is thinking long term, and clearly being aggressive. However, we do not believe that China intends to isolate itself from the world economically. Ultimately, global growth is significantly impacted by the evolution that is taking place in China. The government of China wants to succeed and dominate. For this reason, it makes sense that certain investments may be in the penalty box. However, when growth is cheap and controlling parties are rational, we think a contrary view makes sense.

Summary

Our focus on China in the ETF Think Tank these days has not been coincidental, and the discussion with our members who we share due diligence calls with has opened the door to some deep discussions. ETF Strategists and Financial Advisors who share our mission around security selection understand how structure matters. Growth at a reasonable price (GARP) tends to work especially well when the growth is at a discount. The questions asked during our calls makes us all more aware of risks and how the journey might play out for the upside. Shared insights make us all smarter!

 

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