Investing in China

TL;DR I’m planning to invest a small-ish slice of my portfolio in China exposure. I found five funds (all ETFs for US investors) that make the cut and will most likely go with an equal allocation to each.

I am fairly convinced that we are in the midst of a “Chinese Century” and that, just as the UK (and UK-based firms) were overtaken by the US (and US-based firms) in the 20th century, China (and China-based firms) will overtake the US in the next few decades (if not sooner).

How to capitalize on this view in a not-totally-inefficient way?

Note: In case you find this post perhaps a bit less thoughtful than my other posts so far, it is probably due to the fact that it grew more out of a “hey, this is something I’m looking at, maybe other people would be interested” than “hey, this is a topic I know well and have thought about a lot that I’d like to explain to people”.

Alphabet Shark-Fin Soup

Given that it’s been a communist country for much of the past century, and that it has strong capital controls, it’s no surprise that trading and/or holding shares in Chinese companies is somewhat complicated.

The folks at etf.com have a pretty good overview here, but it’s from 2013, so I did some cross-checking with Wikipedia. Basically, there are many different flavors of shares (some targeted at mainland investors, some targeted at foreign investors, etc.). Here’s the soup:

• A-shares: incorporated on the mainland, quoted in RMB, traded on Shanghai, Shenzhen, or NEEQ (“National Equities Exchange and Quotations”). Not readily open to foreign ownership.
• B-shares: incorporated on the mainland, quoted in USD (Shanghai) or HKD (Shenzen). Open to foreign ownership.
• H-shares: incorporated on the mainland, traded on the Hong Kong Stock Exchange. Not readily open to mainland ownership.
• Red chips: state-owned companies incorporated outside the mainland (mostly in Hong Kong) and traded in Hong Kong.
• P-chips: non-state-owned companies incorporated outside the mainland (e.g., Cayman Islands, Bermuda, BVI) and traded in Hong Kong.
• N-shares: incorporated outside the mainland (e.g., Bermuda, Caymans, BVI, Nevada, Delaware), traded on the NYSE or Nasdaq. (ADRs of H-shares and red chips are also sometimes referred to as N-shares).
• L-shares: more-or-less same as N-shares, but trade on the London Stock Exchange.
• S-chips: more-or-less the same as P-chips, but traded on the Singapore Exchange.

Given the Chinese government’s history, I suspect that P-chips, S-chips, L-shares, and N-shares will face long-term structural disadvantages. I regret that I also have the same suspicion regarding Taiwan-based companies. I also think that there’s a decent chance that the folks in Beijing will create structural advatnages for the “A-Shares”, but who knows.

Go Fund Me

My first step was to look at broad index-tracking ETFs and mutual funds, with an initial screening based on AUM.

Despite the face that this is defnitely a corner of the market where I would expect at least some folks to have alpha-generating abilities, I’m too lazy to track down and monitor those funds/managers over the long haul. I’m not sure how long this bet will take to pay off, but I’m guessing a decade or two at least, and I put more faith on the longevity of institutions that run indices than I do on any active managers (or the folks who select them). So, passive it is.

Although I have no inherent preference between mutual funds and ETFs (more here), I was unable to find any (seriously?) passive, index-tracking mutual funds for China.

Below are details on the funds that made the (AUM-based) cut.

Fees for these ETFs are all a bit on the high side, between 60 and 75 bps, but that’s unfortunately typical for interntaional equities. Furthermore, they’re close enough that I don’t see it as a differentiating factor.

Note: My requirement for breadth excludes “KraneShares CSI China Internet ETF” (KWEB) and “Invesco China Technology ETF” (CQQQ).

iShares MSCI China (MCHI)

MCHI provides broad, market-cap-weighted exposure to a wide array of investable Chinese shares, i.e. H-shares, B-shares, Red-chips, P-chips, and foreign listings. The fund includes large- and midcap companies and also comprises fewer holdings. The fund will generally invest at least 90% of its assets in the component securities of the underlying index and in investments that that are substantially identical to the same. A representative sampling indexing strategy is used in order to manage the fund. The index is reviewed quarterly and rebalanced semi-annually.

Source: Factset via etf.com

More info according to etf.com: Expense ratio 59 bps. Spread ca. 1 bps. Some substantial swings in premium/discount, but nothing persistent (median 3bps). Very similar weights to GXC.

SPDR S&P China (GXC)

GXC tracks an index that attempts comprehensiveness with regards to investing in Chinese shares. The underlying index holds investable Chinese shares across all market-cap sizes. This includes major share classes like A[-shares], B[-shares], H[-shares], red chips, P chips, and foreign listings. The Index is also “float-adjusted,” meaning that only those shares publicly available to investors are included in the Index calculation. Weights are determined by float-adjusted market-cap, as well. Rebalancing is done annually in September with share changes and IPO updates in March, June, and December. Overall, GXC offers a broad exposure to the total Chinese market.

Source: Factset via etf.com

More info according to etf.com: Expense ratio 59 bps. Spread ca. 15 bps. Some substantial swings in premium/discount, but nothing persistent (median 7 bps). Very similar weights to MCHI.

iShares China Large-Cap ETF (FXI)

FXI… is a concentrated portfolio of 50 large cap H-shares, P-chips and Red Chips listed in Hong Kong. FXI draws its selection universe from the FTSE All World Index…. Stock weights are capped at 9% and company weights at 38%.
The index is reconstituted and rebalanced quarterly.

Source: Factset via etf.com

More info according to etf.com: Expense ratio 74bps. Spread ca. 2bps. Some substantial swings in premium/discount, but nothing persistent (median 5bps).

Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR)

ASHR was the first US-listed China ETF capable of accessing the China A-share market directly. The fund is able to hold A-shares in the Shanghai and Shenzhen Stock Exchanges through the subadvisor, Harvest Global Investments, which has an RQFII license up to a specific quota. If the quota is reached, the index will have to either get its quota increased, use derivatives to maintain exposure, or limit or halt creations, so monitoring is warranted. The fund’s focus on mainland A-shares also gives it a large-cap tilt and a heavy bias toward financials. The RQFII quota can make creations difficult. The index is reviewed semi-annually.

Source: Factset via etf.com

More info according to etf.com: Expense ratio 65bps. Spread ca. 3 bps. Some substantial swings in premium/discount, but nothing persistent (median 2bps).

iShares MSCI China A ETF (CNYA)

CNYA offers exposure to a basket of Chinese A-share equities… to reflect the A-shares included in the MSCI Emerging Markets Index, tracked by sibling fund EEM…

Source: Factset via etf.com

It’s a little on the small side, with less than $1 billion in AUM.

More info according to etf.com: Expense ratio 60bps. Spread ca. 11bps. Some substantial swings in premium/discount, but nothing persistent (median 11bps).

Takeaway

I’m going with an equal weight (20% intra-China allocation) to each. This gives me a decent split among providers (although overweight iShares), a decent split among A- and non-A-Shares, and (with the 9%/38% caps) FXI adds (at least in theory) a slight tilt away from market-cap-weights and towards equal weight.

Legal Disclaimer

The information contained on this article is not and should not be construed as investment advice, and does not purport to be and does not express any opinion as to the price at which the securities of any company may trade at any time. The information and opinions provided herein should not be taken as specific advice on the merits of any investment decision. Investors should make their own decisions regarding the prospects of any company discussed herein based on such investors’ own review of publicly available information and should not rely on the information contained herein.

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Note: This disclaimer was shamelessly copied from an old acquaintance of mine, Chris DeMuth Jr. His blog can be well worth reading.