ETF strategy: How to play China

By Covestor

China poses an interesting paradox for ETF investors.

The world's second-biggest economy, which averaged 10% growth rates from 1980 to 2012, is decelerating. China grew 7 percent in the first quarter, the slowest pace since the 2009 global recession.

At the same time, there are the explosive stock market rallies at the country's three major domestic stock exchanges. The Shanghai Composite Index is up nearly 80% over the last 6 months.

 

China stocks

 

Monster Rally

Some $4 trillion has been added to the total market value — now $7.3 trillion — of companies listed on all of China's domestic exchanges over the past year.

It's useful to approach investing in China from a short-term and long-term perspective.

At the moment, Chinese stocks are a huge momentum trade and tech stocks, in particular, look pricey by price-to-earnings measures.

The People's Bank of China, the nation's central bank, has pumped a lot of money into the economy to improve growth and that liquidity has wended its way into the financial markets. Short-term investors should proceed with caution.

 

Long game

The long game in China is the government's quest to guide this $10.4 trillion economy onto a more sustainable and balanced path, with less reliance on debt-fueled investments and the state-sector companies for growth.

Over time, China hopes to build a vibrant service sector, open up its capital markets and promote the expansion of the middle class.

There's evidence the transformation is underway.

In the first quarter, the service sector represented more than 50% of economic growth for the first time.

 

ETF Options

Aside from promising to reduce state intervention in the economy, President Xi Jinping's government seeks to improve the social safety net and encourage market-driven interest and deposit rates to get Chinese families saving less and spending more.

Investors interested in China have an array of exchange traded fund options. There are any number of Chinese-focused investment vehicles such as theiShares MSCI China ETF (MCHI) and SPDR S&P China ETF (GXC) focused on so-called H-shares.

These are companies incorporated in mainland China that are traded on the Hong Kong Stock Exchange, where listing requirements are fairly rigorous.

 

A-Share Funds

Yet in recent years other ETFs have emerged that give U.S.-based investors direct access to China’s so-called A-shares. This refers to the renminbi-denominated shares of companies incorporated in mainland China and traded on the Shanghai and Shenzhen exchanges.

One popular one is the Deutsche X-trackers Harvest CSI 300 China A-Shares Fund (ASHR).

These A-share companies are considered more risky given their reputation for sub-par accounting standards and the large base of short-term, retail investors who typically buy and sell their stock.

However, A-shares do offer diversification benefits to investors as they tend not move in line with the U.S. market.

 

Valuations

Covestor portfolio manager Steve Gluckstein, founder of Seaview Global Advisors, thinks that "a rising proportion of China household savings will be channeled into the stock market, which remains inexpensive (tech stocks aside) on both an absolute and historic basis."

China's days of super-elevated, double-digit growth are probably over. Even so, this vast developing economy has plenty of untapped potential and that may offer interesting opportunities for well-informed investors.

Photo Credit: Phil Wiffen via Flickr Creative Commons

Sanjoy Ghosh is Chief Investment Officer at Covestor (Covestor.com), an online investing marketplace. This article originally appeared in USA Today on May 1.
Covestor Investment Management

Covestor Investment Management

The Covestor Investment Management team under Chief Investment Officer Sanjoy Ghosh manages two types of portfolio. Covestor Core portfolios are

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