ETF provider WisdomTree makes case for ‘Total China’ equity approach

Aug 9th, 2016 | By | Category: Equities

Exchange-traded funds tracking Chinese equities may offer a value proposition, according to ETF provider WisdomTree Europe. In a report to investors, the firm makes a case for a ‘Total China’ approach to investing in the country (namely seeking an investment with access to all of China’s equity share classes), noting robust macroeconomic indicators and equities which are trading at favourable price multiples compared to their historic averages, as supportive of investment in the country.

WisdomTree makes case for new China equity ‘all class’ ETF

The ICBCCS WisdomTree S&P China 500 UCITS ETF (LSE: CHIN) is the first European-listed, physically replicating UCITS ETF to offer exposure to a combination of Chinese equity classes.

At the macro level global fundamentals are supportive of economic growth in the country, finds WisdomTree, highlighting specifically that commodity prices have started to stabilise and government officials are curbing speculation in raw materials prices, most notably in rebar steel.

In a note to investors released in May, ETF provider Source also supports the view that macro fundamentals in China are improving – investment spending grew 10.7% year-on-year to March 2016, while industrial production rose 6.8% and retail sales climbed 10.5% in the same time period. Aggregate financing also rose to CNY6.5tn in Q1, up from CNY4.6tn a year ago, strongly indicating that local financial institutions believe the economy will expand over the medium term. Additionally, although growth has fallen in the country, Q1 GDP still expanded by an annualized rate of 6.7%, significantly above the average for emerging market countries.

Current equity valuations may also be compelling with a particularly upbeat outlook for exporters. WisdomTree writes: “Mainland and offshore Chinese equity benchmarks trade around 16x and 14x trailing P/E, respectively, and well below their historic average. The equity yield premium over bonds also compares favourably against its own history as well as against peers in emerging markets.”

Despite the appeal of attractive valuations, the turbulence of the stock market since its crash in June 2015 may cause investors concerns over whether there could still be structural problems in the market.

As seen in the below graph, speculation (as measured by the proportion of the value of the Shanghai Stock Exchange trading on margin) reached excessive levels of approximately 4% shortly before the market crashed in July 2015. These were similar levels as those observed in the NYSE prior to the US equity collapse in 2008

Source: WisdomTree

Source: WisdomTree

As shown in the graph, Chinese officials have since curbed excessive margin trading, bringing speculation levels on par with US shares traded on the NYSE. While these regulatory changes may allay investors’ fears somewhat, there are still lingering concerns regarding foreign access to China’s A-Share market. Such concerns were cited as the primary reasons behind global index provider MSCI’s decision in June to deny A-Shares inclusion in the widely-followed MSCI Emerging Markets Index for the third year in a row.

With global fundamentals improving, valuations looking attractive, and speculation being pared back, WisdomTree believes investors may now consider a ‘Total China’ approach to investing, highlighting the S&P China 500 Index as a suitable index for ‘Total China’ exposure. The S&P China 500 index comprises the 500 largest Chinese stocks by float adjusted market cap. By including multiple listings of both onshore and offshore shares, the index is able to capture a more balanced sector allocation when compared to most other China equity indices.

Investors may gain exposure to it via the ICBCCS WisdomTree S&P China 500 UCITS ETF (LSE: CHIN), launched by WisdomTree and Hong Kong-based asset manager ICBC Credit Suisse last month. It is the first European-listed, physically replicating UCITS ETF to offer exposure to a combination of Chinese equity classes, and has a total expense ratio of 0.75%.

This strategy tilts towards China’s new economy, potentially allaying investor fears over China’s old economy stocks being burdened by high indebtedness and poor financial performance. The index avoids heavily indebted bureaucratic companies, by reducing the exposure to state-owned enterprises (SOEs), embraces new economy sectors of China, especially IT and consumer stocks that deliver higher return on investments, and allows for a broadly defined China equity universe that is better diversified and reduces volatility to provide better risk-adjusted returns.

The firm writes: “When looking at the last five years’ historic fundamentals of the S&P China 500 constituents, nearly half of the 24 GICS Industry Groups show a median net debt to EBITDA ratio below zero (i.e. negative values). With the overwhelming majority of companies having reported positive operating earnings over the period, cash and liquidity is more than enough to pay down debt.

“In a universe that is otherwise biased towards the large established government controlled companies, the S&P China 500 Index’s all-inclusiveness mitigates such concentration risks and in the process, creates a more balanced, more diversified China exposure where the emphasis on quality stocks offers investors a more efficient exposure to the Chinese equity market.”

Although the ICBCCS WisdomTree S&P China 500 UCITS ETF is the first UCITS-compliant ETF to offer exposure to all Chinese equities share classes, there are a number of significant ETFs currently available targeting either mainland China’s A-Share market or Hong Kong-listed H-Shares, allowing investors to combine ETFs to gain a similar exposure to the WisdomTree fund.

Those targeting A-Shares include the iShares MSCI China A UCITS ETF (LSE: CNYA), which has 433 constituents and a TER of 0.65%; the db x-trackers FTSE China 50 UCITS ETF (LSE: XX25), which tracks the 50 largest companies listed on mainland China and has a TER of 0.60%; and the Source CSOP FTSE China A50 UCITS ETF (LSE: CHNA), which provides the return of the 50 largest companies listed on mainland China and has a TER of 0.99%.

ETFs covering the H-Share market include the iShares China Large Cap UCITS ETF (LSE: IDFX), which targets the 50 largest Chinese stocks listed on the Hong Kong Stock Exchange and has a TER of 0.74%; and the Lyxor China Enterprise (HSCEI) UCITS ETF (LSE: ASIU) which has 40 constituents and a TER of 0.65%.

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