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China ETFs see strong growth as investors seek broader exposure to economic recovery

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Despite being the launch pad for the Covid-19 pandemic that has swept the world and changed it forever, China as an investment destination has kept up in the performance stakes, both in terms of offering performance to external investors and in growing its own domestic asset base.

Despite being the launch pad for the Covid-19 pandemic that has swept the world and changed it forever, China as an investment destination has kept up in the performance stakes, both in terms of offering performance to external investors and in growing its own domestic asset base.

Caroline Baron, Head of EMEA ETF Sales, Franklin Templeton says: “China was one of the first countries out of Covid-19 and it certainly helps to be one of the first to reopen.”

“China took very serious measures early with the Covid-19 outbreak, such as enforcing working from home, social distancing, closure of bars/restaurants and public meeting spaces, as well as strict controls on flights arrivals,” says Andrew Walsh, Head of Passive and ETF Specialist Sales for the UK and Ireland at UBS Asset Management.

“On the economic side, we have seen a whole range of targeted policies to support the economy, such as support for small businesses and easier monetary policy.

“As a result, China was faster to return back to normal, while the rest of the world was still in strict lockdowns. While the economic recovery of China is naturally dependent on the recovery from the rest of the world, it is worth noting that its retail market contributes to 76 per cent of its annual economic growth, according to McKinsey estimates. This could partially explain why China ETFs have performed so well in comparison to other exposures.”

Sjef Pieters, Head of European Sales at China ETF specialists, Krane Funds Advisors, agrees saying China has done well: “It was undervalued by a lot of investors who have ignored China because of the trade war and because it was a relatively small part of the major indices but China did very well last year.”

It’s hard to remember that China is still classed as an emerging market, despite its position as the second largest economy in the world. Against the backdrop of the emerging markets, China has significantly outperformed but may be unrepresented by the existing indices.

Baron says: “Another trend is about the way investors look at China. Last year, investors started to think more about the role of China in their portfolios. Before, it was through a broad-based emerging markets index. Whereas now, they believe that if you look at the weight of China in terms of GDP, the economy is not well represented in the indices. Its weight in terms of the world GDP is 16 per cent against 4.5 per cent in the MSCI ACWI index. Therefore, if you have strong beliefs about China, you may want to play it on its own and we have seen that trend continuing since last year.” 

Investment analysts and consultants bfinance agrees. Its recent report, ‘Rethinking China’s Role in Emerging Market Equity Portfolios’, found that investors are reassessing their approach to investing in Chinese equities, supported by fundamental shifts in asset management offerings.  

The firm found that while four in five investors were still obtaining their China equity exposure solely through Global Emerging Market equity strategies, the firm’s clients were increasingly using dedicated China equity strategies, such as A-Shares funds (for onshore equity exposure) or All-Shares strategies (which blend onshore and offshore capability). 

And this re-evaluation was partly driven by the growth of China’s equity markets, both in terms of index weightings and overall market capitalisation. 

Bfinance writes: “It is also encouraged by rising awareness among investors of the different characteristics of onshore China equities, which are still very under-represented in global indices and Global Emerging Market strategies. More recently, the market turmoil of 2020 has showcased diversification, with a clear divergence between Chinese equities and Global Emerging Markets in Q1: while the MSCI EM index lost 23.60 per cent, the MSCI China A index lost just 9.72 per cent and the MSCI China index (largely offshore) lost 10.22 per cent.”

Carmen González-Calatayud, Head of ETF Capability at HSBC Global Asset Management comments: “China ETFs have clearly benefited from the resilience of a large part of the Chinese market versus some of its other EM and even DM peers during the pandemic. 

“In particular, when considering factors such as a strong healthcare sector, economic growth resilience, external dependence, and policy flexibility, a picture emerges of an economy really well positioned to withstand the Covid-19 shock as well as for making a good recovery. There are some differences within the China ETF segment – and those ETFs tracking broad based indices with a more balanced sector allocation and larger exposures to the onshore market have seen a more solid performance YTD.

“The size and the broadness of the Chinese market in addition to the complexities in terms of the different ways to access the market, often seem to make it more challenging to get the appropriate exposure. The inclusion of the onshore China A shares in most major benchmarks over the last few years has given investors better access to the overall market. 

“As this trend continues and the market becomes more accessible, ETFs that track broader indices with a wider sector exposure are going to benefit from the continued inclusion and therefore offer the more accurate exposure. By the same token, given the vastness of this market becoming ever more accessible, we also expect the demand for more specialised China exposure to increase in the coming years.”

The variety and complexity of routes into China might seem daunting, but ETF providers in the sector universally agree that investors need to do the research to find out what exposure they are getting within their chosen product. Indices vary considerably.

Baron says: “It’s also important to think that there are different ways to play China – through A Shares, H Shares and all types of different stocks with various levels of risk, so investors considering a broad exposure to China should look at indices that are diversified with a mix of different structures as not all China ETFs are the same. Look deeper.”

And then looking forward, there is plenty of room for optimism. Eng Teck Tan, Senior Portfolio Manager at Nikko Asset Management, writes in a note: “Although there is no GDP growth target for China this year, we believe policy supports are still strong enough to enable the Chinese economy to generate positive growth for the whole of 2020. After all, China’s economy is growing at a pace that is much faster than that of the global economy…economic indicators are showing that China’s economy is recovering steadily on the back of work resumption and improving domestic consumption. At the same time, liquidity conditions continue to be accommodative during the economy recovery phase. In our view, the Chinese government will try its best to stabilise the employment level in China by stimulating the economy with loosening monetary policy, while putting up with high fiscal deficits.”

However, he warns that earnings growth for the bulk of Chinese companies in 2020 could continue to disappoint and the recovery in 2021 still looks cloudy for now due to the uncertainties of the Covid-19 pandemic and worsening US-China tensions.

“Despite external uncertainties, the fundamentals of China A-shares continue to improve month by month and industries in China driven by domestic demand have recovered well. For now, we will remain focussed on areas of structural opportunities, preferring domestic-oriented sectors and stocks to those related to overseas demand.

“Domestic support in China has proceeded with increased municipal debt issuances and targeted fiscal stimulus, particularly in areas of strategic industry development, namely 5G, digital, automation and environmental. We remain focussed in these areas of attractively priced structural growth, as well as others in the software, healthcare, insurance and select consumer sub-sectors.

“Over the longer term, Chinese technology stocks, especially in the 5G construction and cloud computing areas that have underperformed of late due to the fears of new US export restrictions, are expected to outperform. The new technology cycle and the rapid pace of digitalisation in the post Covid-19 world should continue benefiting these tech-related stocks.”

KraneShares has drilled down into sectors within China, with ETF offerings in healthcare, internet and even an ESG product. The facts are extraordinary. In terms of the Chinese health care industry domestically, the company believes that the COVID-19 pandemic may cause a surge in global demand for China healthcare companies.

Some 18 per cent of revenue from holdings within KraneShares MSCI All China Healthcare ETF is derived from abroad. Chinese pharmaceutical manufacturers have captured 97 per cent of the US market for antibiotics and 90 per cent of the market for vitamin C.

Its own population is ageing, with an expectation that this will increase the burden of chronic disease by 40 per cent by the year 2030. While China healthcare expenditure is still small compared to the US, it is one of the fastest growing major healthcare markets in the world with a 10-year compound annual growth rate of 13 per cent, compared to just 3 per cent in the United States.

Turning to internet and e-commerce opportunities within China, KraneShares reports that its CSI China Internet UCITS ETF has doubled AUM this quarter from 62.2 to 127 million in assets and is up 29.01 per cent YTD.

What lies behind that growth is, among other things, Chinese retail web sales which totalled USD1.5 trillion in 2019 (compared to USD601.7 billion in the United States).

And there is room for growth. The country has an internet population of 854 million people, which represents a penetration of only 61.2 per cent. The U.S. internet population reached 294 million people, a penetration rate of 89.5 per cent in June 2019.

Total Chinese retail sales reached USD5.5 trillion in 2019 and of that online shopping accounted for 25.8 per cent of retail purchases in China in 20191.

China is going through something of an internet and e-commerce revolution. Its e-commerce market size surpassed the US for the first time in 2014, and China’s total retail sales surpassed total retails sales of the US for the first time in 2017.

And then we have China as a growth area for domestic funds, as revealed in recent figures from EFAMA and the US’s Investment Company Institute whose quarterly International Statistical Release found that Chinese funds increased their share of the global investment market significantly in the first three months of 2020, moving the country up the rankings from tenth to fifth position in a quarter.

The paper shows that China beat established asset management markets, such as France, the UK, Japan and Australia, with 4.1 per cent of worldwide fund assets, against 3.8 per cent for France and 3 per cent for the UK. It was even creeping up on Germany which stands at 4.6 per cent.

The data is for open-ended, regulated funds, including money market funds, globally.

With its ageing population and expanding middle class, China looks set for asset growth across the board, and booming domestic business will underpin its position as an investment destination of choice. 

In conclusion, Nikko’s Eng Teck Tan writes: “As the first country to be hit hard by Covid-19, China could also be the first economy to bounce back from the pandemic and may even emerge stronger, given the rise of its high-tech and digital-economy related industries. As the old adage goes, “What doesn’t kill you, makes you stronger”.

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