This article is part of Morningstar’s Guide to Investing in Asia where we navigate the potential risks, for the chance of fantastic rewards from across the continent.
In China, the economy is transitioning from an export-led growth model to a consumption-driven one. According to China’s Premier Li urbanisation will narrow the income gap between rural and urban residents, and urban household-income will increase at least twofold by 2022. All of these changes create investment opportunities; savvy investors may well be eyeing funds targeting China’s fastest-growing sectors including retail, e-commerce, internet and mobile, while limiting their exposure to heavy industries.
The problem is the European ETF offering exposed to China’s growing businesses is paltry. A host of products track flagship market capitalisation indices, but most of these are heavily exposed to financials. The Hang Seng China Enterprise Index (HSCEI) allocates 70% of its total value to the financial sector, while the FTSE China 50 and MSCI China assign a 52% and 41% weighting to it, respectively.
Overexposure to Problematic Banks
China has loosened its grip on the financial sector by liberalising lending interest rates, allowing institutions to price loans individually. This promotes more competition and efficiency in the banking sector. The quality of bank balance sheet assets is a growing concern for investors though. Many bank loans are strongly exposed to the Chinese property market, which commentators are saying is in bubble territory.
With almost €700 million in assets under management the Lyxor China Enterprise (ASI) is the largest European-domiciled ETF with exposure to Chinese equities. The second largest ETF is the iShares China Large Cap (FXC) tracking the FTSE China 50, but db x-trackers (XX25) also offers an alternative with the same exposure. Covering the A-shares market, the ETFS-E Fund MSCI China A (CASH) offers a lower exposure to financials, but is approximately 20% exposed to the industrial sector.
Starting December 1, MSCI will include N-shares - Chinese companies listed on the New York Stock Exchange - in its MSCI China index. Internet behemoths like Baidu and Alibaba will be in the top ten constituents upon inclusion, lowering overall index exposure to financials and increasing it to technology. Approximately nine out of 10 people in the United States use the internet, but in China only five in 10 do, suggesting potential growth opportunities in this sector.
Getting Sector Specific for Targeted Gains
Aside from broad-based funds, European investors have limited access to sector-specific ETFs covering the Chinese market. Db x-trackers provides a series of CSI300 sector ETFs tracking Chinese A-shares. The CSI300 Consumer Discretionary UCITS ETF (XCHD) offers exposure to household appliances, computer electronics and entertainment.
For exposure to the Chinese pharmaceutical and biotech industry, European investors can look to the CSI300 Health Care UCITS ETF (HKD). Since the beginning of the year, the db x-trackers CSI300 Health Care ETF outperformed the CSI 300 Index by 24.6% while the db x-trackers CSI300 Consumer Discretionary ETF outperformed the same benchmark by 18.9%.
The Dawn of an Internet Boom
The US ETF market offers more targeted options. According to the China Internet Network Information Centre approximately 49 million Chinese used the internet for the first time in 2014. KraneShares, a US asset manager specialising in “new China” products, taps into this market via its CSI China Internet ETF (KWEB0). While db x-trackers offers exposure to consumer durables and household appliances, the Global X China Consumer (CHIQ) ETF covers the growing retail, food, beverages and travel market. Global X also offers a China Technology ETF (QQQC) covering hardware and software, as well as technology and the internet. No European listed ETF provides exposure to the Chinese technology sector yet.
As the face of the Middle Kingdom is changing it is important investors look carefully into their China funds to ensure they are getting the sector exposure they are really seeking.
After the market crash in August Apple CEO Tim Cook said, “I continue to believe that China represents an unprecedented opportunity over the long term.” China remains the world’s fastest growing and second largest economy, but stomach churning volatility makes sector selection perhaps more meaningful now than before. With change, comes innovation. Let’s hope it reaches Europe soon.
The sector ETFs mentioned in this article are incredibly niche products, only suitable for investors with very large, diverse portfolios.
