Western Buyers To Taste A-Shares, Bad Debt

Includes: ASHR, CAF, FXI, PGJ
by: Doug Young

A couple of news bits are showing how a wider range of Chinese investment choices are slowly becoming available to western buyers, including many of riskier quality. Shares of premium Chinese names like top telco China Mobile (HKEx: 941; NYSE: CHL) and leading Internet company Tencent (HKEx: 700, OTCPK:TCEHY) have been available to western investors for years through their overseas-listed shares, mostly traded in New York and Hong Kong. But now a new group of decidedly lower-tier Chinese companies are coming onto the market with 2 new developments. One will see Cinda Asset Management, one of Beijing’s main bad debt aggregators, make an IPO in Hong Kong; the other has seen the first exchange traded fund (ETF) that directly buys and sells China-listed A-shares make its debut in New York.

My advice to anyone thinking of investing in these new products would be to proceed with extreme caution. I personally don’t invest in China stocks, partly because I write about the companies and don’t want to compromise my own objectivity, but also because I consider them far too volatile for my taste. Non-sovereign Chinese debt is an even riskier product, since much of that debt comes from local governments that often use their fund raising for dubious investments. Chinese corporate debt is equally risky, as reflected by the recent bankruptcy of solar panel maker Suntech (NYSE: STP) that has left bondholders with hundreds of millions of dollars in near-worthless debt.

All that said, the new investment options in these latest developments could make an interesting choice for buyers with strong taste for high risk with potentially big rewards. Let’s start off with the latest headlines that say Cinda has won regulatory approval for a Hong Kong IPO to raise up to $2 billion (English article). Cinda is 1 of 4 financial managers set up by Beijing in 1999 to purchase bad debt and other distressed assets from big state-run companies and then sell those assets off.

Cinda is the strongest of the 4 bad debt aggregators, which is why it’s becoming the first to make an IPO. It posted a profit of 7.2 billion yuan ($1.2 billion) in 2012, up 6 percent over 2011. It also counts Switzerland’s UBS (Switzerland: UBSN) and Britain’s Standard Chartered (HKEx: 2888; London: STAN) among its stakeholders, reflecting its appeal to big western institutional buyers.

From Cinda, let’s look quickly at the other news bit that has Deutsche Bank launching the first ETF that lets western investors directly buy A-shares traded in Shanghai and Shenzhen (English article). Such shares are off-limits for most western buyers, though a number of big overseas institutional investors can buy the stocks under China’s Qualified Foreign Institutional Investor (QFII) program.

Deutsche Bank’s newly listed ETF, called the Harvest CSI 300 China A-Shares Fund (NYSE: ASHR), isn’t really the first fund to give western investors exposure to A-share companies. Several other funds already give such exposure, though that comes through derivatives and other accounting maneuvers designed to circumvent China’s strict control of A-share investment by foreigners. By comparison, this new fund uses a partnership with a local fund house to directly invest in the A-share market, and thus should be slightly less risky than the other products on the market.

But of course risk is all relevant, and both this new ETF and Cinda are still highly risky investments in my view. China’s stock market is highly volatile due to the big presence of retail investors. Dubious accounting practices of Chinese companies add to the risk, and a notorious lack of transparency make it difficult to gauge the true value of any financial product. At the end of the day, I would say it’s ok to sample some of these new products for investors who want China exposure, but to keep such investments very limited.

Bottom line: A new IPO for one of China’s bad debt aggregators and launch of an ETF with direct A-share exposure offer new but relatively high-risk options for overseas investors seeking China exposure.