Unique Ideas for Revisiting China ETF Allocations

On one hand, ETF issuers have been doing a lot of cleaning up in their fund lineups. So far in 2024, we’ve seen 16 China-focused ETFs shutter — 18 if we add two that just closed in 2023. It’s been quite the liquidation spree in a single category led by at least five different product providers.

Fund names and closure dates are detailed below (list courtesy of Bloomberg ETF Analyst Henry Jim):

• Direxion Daily CSI 300 China A Share Bear 1X Shares (CHAD ) – 2023-02-17
• AXS Short China Internet ETF (SWEB ) – 2023-06-16
• Global X MSCI China Energy ETF (CHIE C+) – 2024-02-20
• Global X MSCI China Financials ETF (CHIX B) – 2024-02-20
• Global X MSCI China Industrials ETF (CHII A-) – 2024-02-20
• Global X MSCI China Materials ETF (CHIM C+) – 2024-02-20
• Global X MSCI China Communication Services ETF (CHIC A-) – 2024-02-20
• Global X MSCI China Consumer Staples ETF (CHIS ) – 2024-02-20
• Global X MSCI China Health Care ETF (CHIH ) – 2024-02-20
• Global X MSCI China Information Technology ETF (CHIK ) – 2024-02-20
• Global X MSCI China Real Estate ETF (CHIR ) – 2024-02-20
• Global X MSCI China Utilities ETF (CHIU ) – 2024-02-20
• Global X China Biotech Innovation ETF (CHB ) – 2024-02-20
• Xtrackers MSCI China A Inclusion Equity ETF (ASHX B+) – 2024-03-14
• Xtrackers MSCI All China Equity ETF (CN A-) – 2024-03-14
• KraneShares Bloomberg Barclays China Aggregate Bond Inclusion Index ETF (KBND ) – 2024-03-15
• KraneShares CICC China Consumer Leaders Index ETF (KBUY B-) – 2024-03-15
• KraneShares China Innovation ETF (KGRO ) – 2024-03-15

This clean-up comes at an interesting time when the China trade seems to finally be waking up from a long slumber.

The country’s equity ETFs are among the strongest-performing funds this year — best-performing in the past month. In fact, only one global shipping ETF has broken onto the leaderboard of double-digit gains delivered by China-focused ETFs in the last month. Nothing else has come close. See below:

Coming into this year, China equity valuations were on the ground. They were sitting some 60% off highs, with conditions the most oversold they’ve ever been. To quote Brendan Ahern, CIO of KraneShares, “We had never been this underweight China before.” And he means globally, investors everywhere.

That was the case for many reasons. A long track record of underperformance relative to the U.S. from a broad market perspective — consider that the S&P 500 is up more than 900% in the past 15 years, MSCI China is up under 200% in the same time frame — has weighed on the investment case for the country. Add to that constant geopolitical noise, a generally negative narrative around China when it comes to regulation, data clarity, and on-the-ground conditions. The country’s policies around the COVID-19 epidemic didn’t help either. Investor confidence hit a low.

According to World PE Ratio, a website that tracks valuations across the globe, China’s equity market’s P/E is now sitting around 9.6 (post recent recovery). That’s well below rolling averages and much lower than the U.S. stock market’s P/E, which is hovering at 25, and India’s at 24. China is deeply discounted.

But the good news is that past performance is no indication of future results. Today, China ETFs deliver quite the gains, in many ways, as the value play of the day.

Kirsten Chang, senior ETF analyst at VettaFi, called the recent uptick in performance China’s “silent bull cycle.” As she put it in an article this week: “Chinese stocks are quietly rallying back to the brink of a bull market.”

Bull markets are good catalysts for demand or at least for renewed investor curiosity.

If you’re taking note of this burgeoning rally in China equities and are revisiting an allocation to their ETFs, it may be prime time to dive into some due diligence and consider some interesting product development and focused strategies that could replace, complement, or diversify your exposure to the country. There are more ways than one to access this market.

This list of China ETFs is not comprehensive. Just some food for thought:

• Active Opportunity from China Experts: Matthews Asia China Active ETF (MCH B-) and CoreValues Alpha Greater China Growth ETF (CGRO C+)

There’s a lot of China expertise in the ETF space, but some newer-to-ETF firms bring a stated hands-on, laser-focus approach to accessing the region. Matthews Asia and CoreValues Alpha are two examples of active ETF managers that come to mind.

Both firms are doing fundamental research on China companies with a boots-on-the-ground approach. These managers either live in the country or are out there regularly. They’re visiting and interacting face-to-face with the management, production, and operations of the companies they invest in.

Both ETFs have delivered strong results with different approaches. MCH is a broader, sector-diversified portfolio with twice as many holdings as CGRO. That latter fund tilts toward growth with a concentrated portfolio that’s nearly 50% tied to consumer discretionary stocks and has another 30% allocated to technology and communications. CGRO has no allocation to financials, healthcare, or energy (as of May 15, data from VettaFi PRO).

Actively managed ETFs are, in many ways, all about the active manager behind them. So, get to know the teams and the investment philosophy of the teams running these funds to see if they are for you.

• Income-Focused & Possible Buyback Opportunity: KraneShares China Internet and Covered Call Strategy ETF (KLIP ) and KraneShares Bosera MSCI China A 50 Connect Index ETF (KBA A-)

KraneShares is no stranger to innovating in China ETF access. The firm has a long lineup of strategies that are among the most popular and successful ETFs in the space. The issuer is behind one of the most popular and best-performing China ETFs, KWEB, which captures China’s tech growth.

KLIP is an interesting play for a cautious investor from this provider. There’s no other fund quite like it in the space. It accesses China growth while delivering income through options premium. The design is simple: Run a covered call strategy on top of the popular KWEB. The result is some upside market participation with some downside protection and income generation. KLIP, which launched in 2023, is up about 5.5% in the past month.  It has an annualized distribution rate of 42%. Distributions are made monthly.

On another note, one of the interesting supporting factors of the country’s ongoing rally is a resurgence in company buybacks. According to Ahern, companies like JD.com, Alibaba, Tencent, and Baidu are buying back stocks or announcing buybacks this year. These are companies found in KBA’s concentrated portfolio. KBA is a large-cap A-shares fund. However, it could be a beneficiary of this burgeoning buyback story relative to broader, more diversified strategies. Keep an eye on it.

• Quality Opportunity: Pacer Emerging Markets Cash Cows 100 ETF (ECOW )

ECOW is not a China-focused fund. It’s a China-heavy fund. Part of Pacer’s Cash Cows lineup, ECOW has almost 20% tied to China stocks. The five-year-old ETF has $103 million in assets as of May 15.

The fund offers attractive valuation and quality emerging market stocks in one portfolio. It focuses on high-quality, high free-cash-flow-yielding names in its security selection. ECOW also weights the portfolio based on free cash flow yield, and caps single-stock allocations for better diversification. Compared to the MSCI Emerging Markets Value Index, ECOW’s capture of free cash flow yield was higher by some 4 percentage points as of March 31, according to Pacer data.

ECOW’s quality focus could offer some protection, or at least afford some confidence to investors still cautious about jumping into the country. About half the portfolio is allocated to three sectors: industrials, energy, and technology. Its top holdings include COSCO Shipping, PetroChina, JD.com, and China Shenhua Energy.

ECOW is trading at two-year highs. That’s up 8.2% in the past month for annual gains now exceeding 21%.

• Government-Influence-Aware Opportunity: WisdomTree China ex-State-Owned Enterprises Fund (CXSE A-)

CXSE is a veteran, having come to market back in 2012. But it remains a novel idea. For U.S. investors weary of the country’s government influence over a company’s actions and results, CXSE invests only in China companies that are not owned by the state. Ownership is defined as a stake greater than 20%.

The general idea is that state-owned companies may prioritize meeting a government agenda rather than benefiting shareholders regarding decision-making. That could translate to poorer results, or so the investment thesis goes.

In the past month, CXSE has gained nearly 16%. The fund, which tilts toward consumers and tech, has about 34% of its portfolio tied to consumer discretionary names and another 30% tapping technology and communications sectors. Top holdings include the likes of Tencent, Alibaba and Baidu. For perspective, relative to an MSCI-linked broad China ETF like MCHI, CXSE has a lot smaller exposure to sectors such as financials, utilities, and energy.

No one knows whether this bull rally is here to stay. But what started out from oversold conditions, which were mostly technical buying, is now a run-up that’s picking up momentum. That momentum is supported by an improving economic picture. Growth is taking hold. Consumers are coming out of “hibernation,” to quote Ahern. Policy has been timid, but it’s stepping up.

“This rally can be sustainable because the economy is improving,” Ahern said. “It’s a slow rebound after the debilitating effects of zero-COVID on the economy. Domestic demand has been slow. There is a negative wealth effect of falling real estate prices in China’s households. Consumer confidence is low in the country. But it’s a recovery.

“We had a big unwind in China. Now comes the rewind,” he added.

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