Financial stocks have historically been important to dividend oriented portfolios. The 2008 market crash, changed that in the U.S. and in the U.K., but not all over the world. There are still some bank stocks that offer above average yields -- some for attractive reasons, and some not so much.
China is one of the countries where banks tend to have above average yields. Let's see what that really means by taking a look under the hood at a new ETF, the Global X China Financials ETF (CHIX).
CHIX invests exclusively in Chinese financials (banks and insurance companies). We would not be inclined to own a full sector basket of Chinese banks, for dividend and income growth purposes, but the yields may lure some.
Completely separate from the possible motivation of a yield seeking investor reaching overseas for yield, this ETF may be of interest to investors seeking to pair one or more China sector funds with a broad China fund to create a different overall sector exposure.
Whichever of those perspectives an investor may have, we need to look at the index it tracks and the individual stocks underlying the index and the fund. We happen to be inspecting at it from the dividend perspective, but regardless of the reason for your interest, this new fund with a new index and no track record requires a detailed inspection of the parts and pieces inside.
Note: China certainly has its banking issues, sufficient in some cases for calls for a major banking crisis. That crisis potential is related in great part to non-performing loans to local government entities for infrastructure projects that now lay empty, unused or severely underused; and to property developers who are under water. Also, according to some analysts, private banks hold large amounts of state controlled policy bank debt which officially carries an assigned zero risk credit rating that does not reflect the underlying reality. Those analysts question whether the central government would be fully supportive of that debt at the end of the day.
There is no yield data for the fund, but there is yield data for the individual underlying Chinese banks and insurance companies, which we present below. We show the current yield along with the P/E and PEG in a table, then provide price - earnings - yield charts for each of the top ten fund holdings. Let's see what's inside?
- Holdings: 36
- Expense Ratio: 0.65%
- Yield: N/A
- P/E: N/A
Index Performance History Chart From Index Provider:
The Underlying Index (from the ETF):
The Global X China Financials ETF seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Solactive China Financials Index [which] is designed to reflect the performance of the financials sector in China. It is comprised of selected companies which have their main business operations in the financials sector and are domiciled in China or have their main business operations in this country. Only securities which are tradable for foreign investors without restrictions are eligible.
Investment Strategies (from the ETF):
The Fund invests at least 80% of its total assets in the securities of the Underlying Index and in ADRs and GDRs based on the securities in the Underlying Index. The Fund also invests at least 80% of its total assets in securities of financials companies that are domiciled in, principally traded in or whose revenues are primarily from China. For purposes of this policy, financials companies include those engaged in banking, lending, insurance, investments and/or financing.
The Index Company and the Index:
The Underlying Index is defined by Structured Solutions AG. Their work is substantially involved with the custom index demand from the ever expanding list of investment funds that seek to create indexes that they can then follow. The tag line for Structured Solutions from their website is "Your partner for customised investment solutions".
They say this about their business:
Solactive - Innovative index solutions for your success ... Solactive is Structured Solutions' own index platform which is used by international issuers to develop and calculate indices. The platform was founded in 2006 … When it comes to the scope of possible indices that can be calculated by the Solactive index platform the opportunities are endless. Stocks, bonds, commodities as well as mutual funds or other wrappers can be considered as underlyings. The same flexibility can be applied regarding the index calculation methods: price or total return indices as well as excess return indices can be calculated, but also alpha and reverse indices and many more concepts are possible. … Due to the speed of the financial markets it is crucial to have the ability to react quickly to new trends. This is why the process of launching a new index just takes a couple of days. Structured Solutions is a service provider that helps to develop new individual index solutions but can also act purely as a calculation agent.
They do not, as traditional index providers do, provide a methodology to the public defining how they determine which companies are to be in the index, or how they are to be weighted, or what criteria are to be used to delete a security from the index.
They do provide a backtested history of the index, but do not provide the weights of the stocks in the index, in addition to not providing an index methodology.
The index company and the index in this case are not independent of the ETF sponsor. That is an important fact to consider when a fund says it "tracks" an index. This is not at all similar to funds tracking indexes such as the Russell 1000 or S&P 500, or the MSCI All World Index, etc. In those cases, the index is rules driven, the rules are published, and the rules were developed independent of any investment manager. Just keep that in mind -- a rose, is a rose is a rose, BUT unlike roses, not all indexes are equal.
Full Index Constituent List From Solactive:
Note the lack of constituent weights. We had to get the constituent weights from the ETF. Who's leading who here?
Presumably the ETF has the same weights (immediately after rebalancing) as the index, but how are we to know if the Solactive does not publish either the methodology or the constituent weights.
If you click the "downloads" link on the Solactive China Financials webpage, it takes you to a March 2010 listing of the constituents with a next update release date of April 2011, and a yield and P/E. however from 2010, the current data is missing the position weights and the P/E and yield -- and no methodology disclosure.
An unimpressive setup in our view.
Yields, Valuations and Ratings - Top 10 Positions:
This table presents the allocation weight, yield, forward P/E estimate and PEG from Bloomberg, and the rating from Wright Investor Services (liquidity, financial strength, profitability and growth -- see rating definitions on our site)
The top ten positions account for almost 68% of the total assets of the ETF. The lowest yield within the top ten positions is below 1%, and the highest yield is nearly 6%. The allocation weighted yield of the top ten stocks just over 3.5%.
The blended forward estimate P/E is about 9.2. The blended PEG, excluding the 106 PEG of the Agricultural Bank of China is about 0.63.
The yield is not compelling. The P/E seems OK. The PEG below 1, pretty much across the board raises our eyebrows about the growth rate and the possible implications for loan losses. With a P/E of 9.2 and a PEG of 0.63, the implied forward growth rate is about 14.6%. That is about twice the growth projections for the Chinese economy.
Given that the country is already overbuilt for infrastructure and housing (at least urban housing), where will the profits growth come from at that rate for another 5 years. Maybe the growth will come from expense reduction, and maybe from asset and loan growth, and maybe from unrecognized loan losses. Teasing out the source of that growth would be valuable for someone with the tools, data and skills to that.
Solactive does not publish an index yield and we have not studied the remaining 26 stock in the ETF. We are guessing that ETF yield will be in the vicinity of 2.9% when the expense ratio is taken out (assumes the remaining stocks have the same approximate blended yield as the top 10).
Comparison With S&P 500 Financials and KBW Major Banks:
The S&P 500 Financials ETF (XLF), according to Morningstar, has a prospective yield of 2.24%, a forward P/E of 12.43, long-term growth of 10.09%, and a PEG of 1.23, and an expense ratio of 18 basis points.
The KBW Major U.S. Banks ETF (KBE) has a prospective yield of 2.26%, a forward P/E of 12.92, long-term growth of 8.79%, a PEG of 1.47, and 35 basis point expense ratio.
Based on only the blended weights of the top ten positions, the Solactive China Financials , has a prospective yield of about 2.9%, a forward P/E of about 9.2, a long-term growth rate of about 14.6%, a PEG of 0.63, and an expense ratio of 65 basis points.
If the Chinese banks in fact are as profitable as they report (proper loan loss accounting, with quality going forward underwriting, and freedom from politically controlled lending), and if they can truly grow at nearly 15% per year for the next 5 years; they may be worth a look by dividend investors. However, for a margin of safety, we would suggest a substantial discount to those numbers for the reasons cited, making this an unattractive option compared to U.S. domestic financials.
Price, Earnings and Yield Charts - Top 10 Positions:
Summary Business Descriptions:
Bank of China Limited is a China-based commercial bank. The Bank operates its businesses through commercial banking, including corporate banking, such as corporate deposits, loans, international settlements and trade financing services, among others, personal banking services, such as personal savings, loans, private banking services and bank card services, as well as financial market services, such as asset management, fund distribution and custody services, as well as management of enterprise annuity fund, among others; investment banking services, including listed financing, financial consulting, securities distribution, research on investment and asset management services; insurance business, including personal insurance, vehicle insurance and marine insurance, among others, as well as investment business.
China Construction Bank Corporation is a commercial bank. The Bank operates its businesses through corporate banking business, including corporate deposit, corporate credit loan, asset custody, enterprise annuity, trade financing, international settlement, international financing and value-added services, among others; personal banking business, including personal deposit, loan, bank card services, foreign exchange trading and gold trading, among others, as well as capital business. The Bank also involves in provision of electronic banking, online banking, mobile phone banking and telephone banking services, equity investment, as well as fund management and banking investment businesses. The Bank operates its businesses in domestic and overseas markets.
Industrial and Commercial Bank of China Limited is a commercial bank. The Bank provides personal banking services, including personal deposits, personal loans, bank cards, credit cards, fund investment and personal financing services, among others; corporate banking services, including corporate deposits, loans, international settlements, international financing, management of corporate annuity, assets custody, investment banking and trade financing services, among others; electronic banking services, including online banking, telephone banking and mobile phone banking services, among others, as well as self-service banking business. The Bank also involves in provision of financial consulting and charge agency services. As of December 31, 2010, the Bank had 16,227 offices and branches in China.
China Life Insurance Company Limited is a life insurance company. The Company through its subsidiaries is engaged in writing of life insurance business, providing life, annuities, accident and health insurance products in China. It operates in four segments: Individual life insurance business (Individual life), Group life insurance business (Group life), Short-term insurance business (Short-term) and Corporate and other business (Corporate & other). Individual life business relates primarily to the sale of long-term life insurance contracts and universal life contracts. Group life relates primarily to the sale of insurance contracts and investment contracts. Short-term relates primarily to the sale of short-term insurance contracts. Corporate and other business relates primarily to income and allocated cost of insurance agency business in respect of the provision of services to CLIC.
Ping An Insurance (Group) Company of China, Ltd. is a company principally engaged in insurance business. The Company operates its businesses through life insurance, including individual and group life insurances, health insurances and bank insurances; property insurance, including motor vehicle insurances, non motor vehicle insurances, as well as casualty and health insurances; banking business, as well as investment business, including securities broking, asset management services, trust and fund business, among others. The Company also involves in provision of reinsurance services.
China Overseas Land & Investment Ltd. is an investment holding company. The Company, along with its subsidiaries, is engaged in property development and investment, real estate agency and management, and treasury operations. The Company operates in three segments: property development, which includes proceeds from sale of properties; property investment, which includes property rentals, and other operations, which includes revenue from real estate agency and management services, as well as building design consultancy services. Its property development, property investment and other activities are carried out in Hong Kong, Macau and other regions in the People's Republic of China. During the year ended December 31, 2011, it acquired 18 parcels of land in 16 mainland cities in China, including Changsha, Changchun, Yantai, Qingdao, Nanchang, Shenzhen, Xiamen, Nanjing, Ningbo, Wuhan, Dalian, Zhongshan, Suzhou, Chengdu, Xi'an and Guangzhou, as well as two parcels of land in Hong Kong.
China Pacific Insurance (Group) Co., Ltd. is a provider of insurance services. The Company operates its businesses through life insurance business, including individual life insurances, group life insurances, as well as short term casualty and health insurances, among others; property insurance business, including motor vehicle insurances and non motor vehicle insurances, as well as asset management business, including bond investment, equity investment and infrastructure investment, among others. Through its subsidiaries, the Company also involves in provision of endowment insurance services. It operates its businesses primarily in domestic market.
China Merchants Bank Co., Ltd. is a China-based commercial bank. The Bank operates its businesses through personal banking business, including personal savings, personal loans, investment banking, foreign exchange trading, gold trading and bank card services, among others; corporate banking business, including corporate savings, corporate loans, international settlements, trade financing, assets custody, financing leasing services and corporate annuities, among others, as well as online banking services and electronic banking services. As of December 31, 2010, the Bank had 73 branches and 749 sub-branches, two specialty operation sites, one representative and 1,913 self-service banks in China. The Bank also operates its businesses in the United States and United Kingdom.
Agricultural Bank of China Limited is a commercial bank. The Bank operates its businesses primarily through corporate banking, including corporate deposit, corporate loan, note discount, small-sized corporate services, organization business, settlement and cash management, trade financing and international settlement, investment banking, capital custody and pension businesses; personal banking, including personal loan, personal deposit, bank card, agent distribution of fund, agent distribution of national debt and private banking businesses; capital business, including currency market business, portfolio investment management, agent capital trading, banking and precious metal businesses, as well as e-banking, including online banking, telephone banking, mobile financial business, self-service banking and e-commerce. The Bank operates its businesses in domestic and overseas markets. It operates branches and representatives in Sydney, New York, London and Singapore, among others.
Bank of Communications Co., Ltd. is engaged in the provision of banking and related financial services. The Bank, along with its subsidiaries, is engaged in the provision of corporate and personal banking services, conducting treasury business, the provision of asset management, trustee, insurance, finance leasing and other financial services. It has four segments: corporate banking, which include corporate loans, bills, trade finance, corporate deposits and remittance; retail banking, which comprises retail loans, retail deposits, credit card and remittance; treasury, which includes money market placements and takings, investment in securities, and securities sold subject to linked repurchase agreements, and other, which includes items not in other segments. As of December 31, 2010, it had 128 domestic branches. Its subsidiaries are Kiu Fai Company Limited and Creative Mart Limited. On January 27, 2010, it acquired 51% interest of China Life-CMG Life Assurance Company Ltd.
China and Its Banks Not Doing As Well as the U.S. and Its Banks:
In the last few years, the Chinese market has been declining, while the U.S. market has been rising.
That is more clear looking at this chart of the performance of the S&P 500 and the Shanghai stock exchange from pre-crash 2007 levels.
Over the past year, S&P 500 financials and KBW Major U.S. Banks have outperformed the Solactive China Financials index . We don't have longer data to plot for the Solactive index, but expect the pattern would be similar to the broad market movements.
We would prefer to wait on China generally, and China financials specifically, although we have a position in the Matthews China Dividend mutual fund, an actively managed fund.
We do not think this set of financial stock should be appealing to investors concerned with a combination of yield, yield consistency and dividend growth. Other countries may provide better opportunities, which we will review in subsequent articles.
We think that dividend oriented investors should seek active management funds in emerging markets, because active funds have the ability to look into the companies more deeply than is possible for the retail investor located in the United States.
Disclosure: QVM has positions in Matthews China Dividend mutual fund as of the creation date of this article (April 26, 2012).
General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.
Extra Risk on Non-U.S. Exchanges: If securities on non-U.S. exchanges were identified, this disclaimer applies to those securities.