By The ETF Professor
Although Hong Kong is not an emerging market in the eyes of some index providers, its status as a territory of China and most frequently used avenue for foreign investors to gain access to Chinese stocks gives it an intimate relationship with the world's second-largest economy.
Until recently, major China ETFs like the iShares China Large-Cap ETF (NYSEARCA:FXI) have struggled, but even as FXI has lost 3.1 percent this year, the iShares MSCI Hong Kong ETF (NYSEARCA:EWH) has gained 3.4 percent.
In the process, EWH has mostly dodged the SHIBOR flap that raised concerns about liquidity in the Chinese banking system despite its own 59.3 percent weight to the financial services sector, one that is more than 600 basis points in excess of FXI's weight to the same sector.
Despite the recent out-performance of the Hang Seng, Hong Kong's benchmark index, there are opposing viewpoints on Hong Kong stocks. As is the case in China, Hong Kong equities are cheap. The gauge of Chinese shares listed in the city traded at 7.8 times forecast profits on Sept. 13, the lowest in Asia, according to Bloomberg.
However, a big part of the reason Hong Kong stocks have rallied is the technology sector, including stocks like Tencent Holdings, China's largest Internet company, Bloomberg noted. Hong Kong ETFs are not heavily allocated to that sector.
EWH has a 1.5 percent weight to tech while the First Trust Hong Kong AlphaDEX Fund (NASDAQ:FHK) has a 2.1 percent weight to the sector. Investors can get more exposure to Tencent with a social media ETF than with a Hong Kong fund.
The discounts offered by Hong Kong shares are alluring and FHK is steeply discounted with a P/E of 6.55 and a price-to-book ratio below one. However, the Hang Seng has rallied nearly 20 percent since June, but the three-month gains for Hong Kong ETFs are nowhere close to that. FHK is up 4.9 percent.
Some even contend that the valuations are not compelling. Goldman Sachs said it expects Hong Kong to underperform other Asian markets over the next year because valuations are not tempting and investors are already over-allocated to the island's stocks. Goldman expects a 50 basis point rise in rates over a short period would translate into a 10 percent valuation downside for the market, according to CNBC.
The problem is the Hong Kong dollar is pegged to the U.S. dollar and if U.S. interest rates further rise, creating more strength for the greenback, Hong Kong exporters will feel the pain. A stronger dollar could slow earnings growth in Hong Kong.
Goldman has an Underweight rating on Hong Kong, the same rating the bank has on Indonesia.
One Hong Kong ETF that has impressed in recent months is the iShares FTSE China ETF (NASDAQ:FCHI). Up 10 percent in the past three months, FCHI tracks large- and mid-cap Chinese stocks listed in Hong Kong. The oft-overlooked ETF allocated 8.6 percent of its weight to technology stocks, including a 7.2 percent weight to Tencent.
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