MCHI: Does Opportunity Beckon In China?

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About: iShares MSCI China ETF (MCHI), Includes: IVV
by: ETF Monkey
Summary

I previously wrote an article sharing 5 ETFs For A Possible Bounce In Emerging Markets. One of those ETFs was MCHI.

Given recent conditions, I decided to do a deeper dive into this ETF.

For investors willing to take on some risk, taking a gamble on China may offer potential for market-beating gains.

Back in September, I wrote an article entitled 5 ETFs For A Possible Bounce In Emerging Markets. While 4 of the 5 ETFs covered the entire emerging market spectrum, I concluded by briefly featuring an ETF specifically dedicated to China, the iShares MSCI China ETF (MCHI).

Recent events caused me to decide to take a yet closer look at both the prospects for the China market in 2019, as well as MCHI. Before I go any further, let me be clear that this is somewhat of a departure from my normal themes of low expenses and diversification. This ETF is not for the faint of heart, as there is much that is uncertain about the near-term prospects for China. At the same time, it may be exactly for this reason that Chinese shares are relatively cheap, in other words that opportunity beckons.

Trump & Xi - A Delicate Dance

It is no secret that the U.S. is currently embroiled in a trade war with China. Just this past week, President Trump reiterated his threat to raise tariffs on more than $200 billion of Chinese goods to 25% in January. Among other things, Apple Inc.'s (AAPL) stock dropped in response, as Trump said in the interview that could include tariffs on Apple products imported from China, including iPhones and laptops.

At the same time, things aren't exactly going perfectly here in the U.S. The U.S. stock market has thrown a fairly significant tantrum in Q4, with the NASDAQ index giving back almost all of its whopping 16.56% YTD gain as of the end of Q3 at one point, though it has recovered some of that this past week. And then there was General Motors' (GM) shocking announcement that it was cutting 14,700 jobs, including thousands in Ohio, directly in contrast with President Trump's campaign promises to the effect that such jobs would be coming back to America.

As a result, as an article in the New York Times puts it, Trump could well seek a truce with President Xi Jinpeng of China when they get together at the G-20 summit meeting this weekend in Buenos Aires.

As it turns out, there was a deal made, of sorts. At this point, however, both the U.S. and China are offering slightly different versions of what was agreed to. Both the U.S. and China markets appeared to take the outcome positively, and rose sharply during the trading session on Monday. Setting that aside for a second, what we do know is that China is down roughly 20% YTD. And that may open the door to gains in 2019.

Enter MCHI

There are only a limited number of ETFs available to investors who may seek a targeted investment in China. In my earlier article, MCHI was the one I included because my research at the time led me to the conclusion that it was perhaps the best of the bunch.

MCHI tracks the MSCI China Index. Here, from MCHI's prospectus, is some detail concerning the index:

[The MSCI China Index] is a free float-adjusted market capitalization-weighted index designed to measure the performance of equity securities in the top 85% in market capitalization of the Chinese equity securities markets, as represented by the H-shares (securities of companies incorporated in the People’s Republic of China (“PRC”) that are denominated in Hong Kong dollars and listed on the Stock Exchange of Hong Kong) and B-shares (securities of companies incorporated in the PRC that are denominated in U.S. dollars (in the case of the Shanghai Stock Exchange (“SSE”)) or Hong Kong dollars (in the case of the Shenzhen Stock Exchange (“SZSE”)) and listed on the SSE and the SZSE) markets.

. . .

Beginning on May 31, 2018, the Underlying Index will also include A-shares (securities of companies incorporated in the PRC that are denominated in renminbi and listed on the SSE and the SZSE).

MCHI carries an expense ratio of .62%. While this is higher than most of the ETFs I cover, as I alluded to earlier, it is still one of the lowest in its asset class. Further, with $3.70 billion in AUM and an average trading volume of $356 million, the fund is quite liquid and manages to maintain a tight trading spread of .02%. The fund is quite diversified for this asset class, with 294 holdings as of this writing.

Here is a look at MCHI's Top 10 holdings:

MCHI Top 10 Holdings Source: iShares MCHI Product Page

As can quickly be seen from perusing that Top 10, MCHI tilts towards communications and financials in terms of its sector weightings, and away from industrials.

Price and Value vs. The U.S.

As mentioned earlier in the article, a focused investment in China is not without its risks. Here is how some of these are frankly explained in MCHI's prospectus.

Many Asian countries are subject to political risk, including political instability, corruption and regional conflict with neighboring countries. North Korea and South Korea each have substantial military capabilities, and historical tensions between the two countries present the risk of war; in the recent past, these tensions have escalated. Any outbreak of hostilities between the two countries could have a severe adverse effect on the entire Asian region. In addition, many Asian countries are subject to social and labor risks associated with demands for improved political, economic and social conditions.

Here, though, is the flip side. Have a look at MCHI's portfolio characteristics.

MCHI Portfolio Characteristics Source: iShares MCHI Product Page

Now, here is that same section for iShares Core S&P 500 ETF (IVV).

IVV Portfolio Characteristics Source: iShares IVV Product Page

In summary, both the P/E ratio and P/B ratio of the stocks held by MCHI are less than half their U.S counterparts. But how do things look for China, moving forward in 2019? I'll leave you with this article, from China Daily. Here's just one quick quote from the article, to whet your appetite.

Bank of China Ltd forecast that gross domestic product in China will grow by 6.5 percent in 2019, 0.1 percentage point lower than the estimated full-year GDP growth this year.

So there you have it, a forecast of 6.5% GDP growth combined with a P/E ratio under 12.

Summary and Conclusion

A targeted investment in China is certainly not for the faint of heart. On the other hand, it may indeed be the case that opportunity beckons for those able to take advantage of it.

Lastly, if you like the overall idea of investing at least some funds in China, but perhaps using a vehicle that is slightly more diversified, go back and take a second look at that earlier article I linked at the outset of this article. In each of the 4 emerging market ETFs I share, you will find that several of MCHI's Top 10 holdings also make it into the Top 10 of those ETFs as well, just in slightly diluted form.

Whatever your decision, until next time I wish you . . .

Happy investing!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult with their personal tax or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.