Talking China Sector ETFs With Bruno del Ama

by on December 23, 2009 | ETFs Mentioned:

Bruno del Ama is the CEO of Global X Management, the New York-based ETF issuer behind several of the innovative exchange-traded products to hit the market in recent months, including the first ETFs offering investors exposure to Colombia and the Nordic region and the first sector-specific China ETFs. He recently took time out of his busy schedule to talk about China, ETF innovation, and more with ETF Database.

Bruno del Ama is the CEO of Global XETF Database (ETFdb): Global X is has just launched a line of sector-specific China ETFs, including funds focusing on technology (CHIB), energy (CHIE), financials (CHIX), consumer products (CHIQ), and industrials (CHII). What do these ETFs offer to investors?

Bruno del Ama (BD): These ETFs offer focused access to specific sectors of the Chinese economy, similar to what sector SPDRs offer in the U.S.  As a point of comparison, there are 400-plus ETFs in the U.S. that offer exposure to various segments of the U.S. equity market.  By contrast, the options in China are very limited. And of the existing ETFs that offer China exposure, almost all of them focus primarily on mega-cap companies.

China is a massive economy – the third largest economy in the world – and has been growing at about 15% over the last ten years compared to 3% to 8% for developed markets.  As a result, certain investors have an increasing need for tools that offer more targeted access to Chinese investments.  Historically, investing in this market was an “all or nothing” game. Investors weren’t able to easily access, for example, the Chinese industrials sector without also getting exposure to financials and energy companies. So we are setting out to expand the tools available to investors by giving them different ways to play China.

ETFdb: Dr. Burton Malkiel has long been of the belief that U.S. investors are underexposed to China. Do you agree with his view? If so, do you have any theories as to why they might be slow to adapt to China?

BD: I agree that most U.S. investors are underexposed to anything outside of the U.S. If you look at the size of equity markets in the U.S. versus the rest of the world and compare it to common portfolio allocations, you see very quickly that investors tend to tilt holdings heavily towards U.S. equities instead of spreading exposure based on the relative size of the various markets.

But this home country bias is changing, and investors are beginning to seek out more international exposure. I think part of the reason why investors have been slow to embrace international equities is simply because it wasn’t easy to do. A good example is China. A lot of people who are investing in China today were not investing in China before some of the ETFs currently offered were out there. It is now a lot easier and less expensive to gain international exposure – ETFs are facilitating that and it is clear that the demand exists.

ETFdb: Let’s talk about exposure to the consumer sector in China. It goes unnoticed that FXI, by far the biggest China ETF, has almost no exposure to the consumer industry. Why is exposure to this part of the Chinese economy important, and how might CHIQ fit into a portfolio?

BD: Historically, the industrial sector has driven growth in China. But looking ahead, many investors expect the developing consumer base in China to play a major role in the country’s growth. Consumer spending in China accounts for only about 35% of GDP, half the level of the U.S., so there is significant room for growth. There are a number of factors that are likely to trigger this growth, such as income and credit growth, demographic trends, and even incentives from the Chinese government.

Incomes are growing along with the economy. For example, millions of Chinese are moving into the $5,000 to $6,000 salary base, which is when consumers typically start moving from pure staple type consumption to actually starting to consume discretionary items. The development of the credit industry, including credit cards, is also likely to have a positive impact on consumption – any growth in credit should have a positive impact on spending.

Another key factor is demographics. Historically, the working population in China had been growing much more rapidly than the population as a whole. This growth facilitates the development of a big production machine, but this segment of the population was in the saving part of their life cycle. For the last 10-20 years, as these workers have been getting older, they have started migrating from saving to spending in their life cycles. This inevitable process will trigger significant growth in consumption within China.  As far reached as it sounds, China will probably end up consuming more than it actually produces at some point in the future.

In addition to these trends, the Chinese government wants to decrease the reliance of the economy on exports by developing a consumer base in China.  To this end, they are providing tax incentives for spending on certain products, as well as developing universal healthcare, so the Chinese population can feel more secure that their health care is covered and thus save less and spend more.

With many mega cap ETFs, exposure to the consumer sector could be from nothing to a maximum of 10%. But a consumer-focused ETF allows investors to specifically target this part of the economy.

ETFdb: What are some of the other trends in China and how will they impact the other sector ETFs that Global X offers?

The overarching trend is the rapid growth in the Chinese economy, which is driving strong growth across the various industries. But each sector has different dynamics at play.  The Industrials ETF offers access to the incredibly efficient manufacturing sector in China.  More recently, there has been a drive towards directing these efficiencies towards higher value, technology-based products and services, which the Technology ETF taps into.

With regards to energy, China will soon become the world’s biggest energy consumer.  There is insatiable demand for energy and commodities, given the rapid expansion of the economy, and the Energy and the upcoming Materials ETFs provide access to this growth.

The Financials ETF is very interesting as well.  The financial markets, still in the early stages of development, are the cornerstone of China’s ongoing transition from a planned economy to a market-driven economy. Each sector ETF has a different story to tell. The Global X family of China sector ETFs allows investors to weight these sectors based on their expectations of how the story will play out, as opposed to simply accepting the composition of a mega-cap focused index. It really comes back to providing options for investors that want to go deeper than what was previously available.

ETFdb: A number of Chinese companies have been very active in establishing operations outside their home country, in both developed and emerging markets. When China has tried to accomplish this in the past, it often caused a political firestorm. But now there are parts of the world that seem almost desperate for investment from China since it has been a global growth engine. Has this opened up new opportunities?

BD: China’s diplomatic status has improved significantly as its economy expanded. The Chinese government is also unique in that it can afford the luxury to plan 10, 20, 30 years down the road. They recognize, for example, that there will be a lot more people driving cars and motorcycles, meaning consumption of oil and energy will surge dramatically. So China is diversifying its energy sources, and becoming quite aggressive securing offshore contracts. They are seeking all sorts of commodities – not just energy, but basic materials and other resources as well.

ETFdb: Shifting gears from China to Latin America – let’s talk about Colombia. Tell us a little about the Global X Colombia ETF. Why is there more to Latin America than Rio De Janeiro?

BD: If you look at Latin American funds, they typically have very low exposure to Colombia, in the range of 1-3%, typically through the only two ADRs available in the U.S. for that market. But Colombia represents about 8% of the regional GDP and capital market size.

For the region, there are ETFs targeting Brazil, Mexico, Chile, Peru and now Colombia. Most people recognize that Brazil and Mexico have the largest economist in the region. Perhaps less known is the fact that Colombia’s GDP is larger than Chile’s and twice the size of Peru’s.

My perceptions of Colombia were, like those of most people, quite negative.  And there are good historical reasons for this. But the country has made tremendous progress over the last decade. If you fly into Bogota or Medellín, you find that it is a safer place than say Mexico City or many other places in Latin America.

Colombia is much more developed than most people realize. It has a population of over 40 million people. A lot of displaced talent returned to Colombia following the dramatic improvement in security. And because of the lack of foreign investment historically, most of the businesses remain in Colombian hands. This compares to a country like Argentina, which has a fairly large economy, but whose equity capital market is rather small because most of the large businesses, be it the airlines or oil companies, are owned by foreign companies.

Colombia also has a fairly diversified economy, with financials, oil, a production economy, and a consumer economy. And it is a great diversifying agent to an U.S. or even Latin American portfolio: its correlation with Latin America is only about 35%. Moreover, the volatility of the Colombian stock market over the last 3 years has been lower than the volatility of the S&P 500.

ETFdb: Some very interesting products and insights. Thanks for taking the time to speak with ETF Database!