Seeking Alpha

How To Play The Upcoming China Meltup

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Includes: ASHX, CNYA, EEM
by: Michael A. Gayed, CFA
Summary

It has been 9 years since China surpassed Japan as the second largest economy in the world.

There are three main categories of Chinese stocks, A-shares, H-shares, and N-shares.

As indices increase allocations to mainland shares, all the corresponding ETFs and mutual funds will follow along to keep their investments in-line with their index.

Study the past, if you would divine the future. – Confucius

It has been 9 years since China surpassed Japan as the second largest economy in the world. They are set to overtake the US for the top spot in another 10 years. Most investors’ portfolios do not reflect this weighting in their investment allocation. In some widely tracked indices such as the FTSE All World Index, the US has a weighting of 55.1%, whereas China is only at 3.4%. This is starting to change, and Chinese stocks should benefit. MSCI, one of the largest index providers, decided to add and increase the allocation to Chinese A-shares in their Emerging Markets Index.

There are three main categories of Chinese stocks, A-shares, H-shares, and N-shares. The H-shares are listed in Hong Kong and the N-shares are listed in New York. These are what most ETFs and mutual funds own. They are the names many people would recognize such as Alibaba (NYSE:BABA), Tencent (OTCPK:TCEHY), and Baidu (NASDAQ:BIDU). The A-shares are the mainland Chinese shares which historically had many restrictions on ownership, but those restrictions are being relaxed. Most Americans wouldn’t recognize the A-share names and they are very heavily weighted towards the financial sector.

As indices increase allocations to mainland shares, all the corresponding ETFs and mutual funds will follow along to keep their investments in-line with their index. This should give a boost to Chinese stocks. Besides this boost from a technical change, Chinese stocks should also benefit from an economy that is becoming more self-reliant and open. Even with the tariff negotiations with the US, China’s GDP grew at an 8.3% rate for the second quarter. They have been able to secure increased trade with Mexico, Russia, and India.

With Chinese markets underperforming the US and World markets, now could be a good time to increase your Chinese allocation in your portfolio and gain exposure to the A-shares. One investment that does that job is X-trackers Harvest CSI 300 China A ETF (ASHR). It tries to follow the CSI 300, which are the 300 largest mainland companies. The fund has been around since 2014 and gives great exposure to a new market. Even with over 300 holdings making up the fund, it is quite concentrated, with the top 5 holdings making up 20% of assets. The largest names are Ping An Insurance, Kweichow Moutai, China Merchants Bank, Gree Electric Appliances, and Wuliangye Yibin Co.

It is heavily weighted to Financial Services at 33.7% of assets, which will make the fund very sensitive to interest rates. The fund offers a 1.07% dividend yield and only charges a 0.66% expense ratio which is below the average emerging markets ETF. Even with the relaxed investment rules, it is still very difficult for the average investor to understand these companies and buy a diversified basket of stocks. X-trackers offers a great way to invest in China without all the legal logistics required to buy stocks directly.

A less direct way to increase your Chinese exposure would be to buy the iShares MSCI Emerging Markets ETF (EEM). The value of Chinese A-shares is set to increase again in November. The total Chinese weight is 32.5% of assets. By November, the fund is expected to have an allocation of 29.4% to China (H- & N-shares) and 3.3% to Chinese A-shares. While EEM offers less Chinese A-share exposure, it does give investors greater diversification than ASHR. EEM’s assets are split evenly at 24% each to Financial Services and Technology sectors. Plus gives investors a solid exposure to South Korea, Brazil, Taiwan, and India. The expense ratio is similar at 0.67%, but the yield is more rewarding at 2.2%.

A new offering is the iShares MSCI China A ETF (CNYA). This ETF also owns about 300 of the largest Chinese A-share companies. This is a newer offering with an inception date of June 2016 and very slim trading volume. The yield is only 0.6%, which is much lower than ASHR. The top 10 holdings have much overlap with ASHR. It is a fund to watch and as it grows more liquid, it could be a good addition to a global portfolio.

Chinese N-shares are making headlines this week. They came under fire from President Trump as a negotiating tool in the US-China trade war. President Trump threatened to delist Chinese companies from US exchanges. There were very few details provided how or when the delisting would happen, but it caused a major sell-off of Chinese shares. Alibaba, JD.com (JD), and Baidu Inc. all dropped between 3%-5% for the day. Many investors may not realize they own these Chinese shares through mutual funds and ETFs. They are widely held in common funds such as the Vanguard Primecap Fund, the T. Rowe Price Blue Chip Fund and the American Funds Growth Fund of America. Before diving into these stocks that might get caught up in trade negotiations, be sure to check your current allocation through funds you already own.

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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.

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