China ETFs’ recent gyrations are enough to give one whiplash. Many have behaved like the Shanghai Composite Index recently. After soaring 152% over the previous 12 months — 60% this year alone — to a seven-year high on June 12, the benchmark for mainland China’s stock market hit a significant speed bump.
Last week the index stumbled 13% into a much-anticipated correction. A 5% rally the first three days of this week gave way to selling Thursday, cutting the week’s gain so far to 1%.
“The sheer increase in prices this year is something that makes me want to stand back,” said John Rutledge, chief investment strategist for Safanad, an investment house in New York. “I don’t know any fundamental reason why prices should have doubled this year, and that price behavior sounds like a bubble.”
Rutledge is referring to the fact that the Chinese economy’s growth rate has slowed to a six-year low of 7%. But if fundamental analysis can’t explain it, macroeconomics can. With central banks all over the world cutting interest rates, there is flood of liquidity looking for returns.
The first thing to know is that there are two markets in China. The Hong Kong market, which has long been open to global investors, trades what are known as H-shares. Then there are the mainland markets in Shanghai and Shenzhen. They trade A-shares, which had been limited to domestic investors.
But last year the Shanghai and Hong Kong markets created a system that let global investors buy A-shares and domestic investors buy H-shares. This change has brought a lot of money to the mainland markets.
On top of that, the People’s Bank of China, the country’s central bank, has cut interest rates three times since November, and more cuts are expected.
Finally, throw in a slowdown in the Chinese real estate market. It led the Chinese government to encourage investments in stocks by making it easier for Chinese retail investors to open accounts and buy stocks on margin.
Loss Of Liquidity
And a loss of liquidity sparked last week’s correction. First, Chinese regulators, worried that the market was getting overleveraged, tightened the rules on margin trading. Then a slew of initial public offerings sucked up a lot of cash.
There’s no doubt that China is risky. But gains could resume if the economy picks up and government stimulus programs continue. And index provider MSCI is evaluating A-shares for inclusion in its emerging markets index. That could spark demand by many funds that track MSCI indexes.
If you want China A-Shares in your portfolio, investing in ETFs is the way to go. KraneShares offers four ETFs focused on China. Its Bosera MSCI China A ETF (ARCA:KBA) holds more than 300 large-cap and midcap stocks on both the Shanghai and Shenzhen stock exchanges.
KraneShares says that these are the stocks that would be included in an MSCI emerging markets index. KBA is up 40% year to date and 126% in the past 12 months. It has an expense ratio of 0.85%.
Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ARCA:ASHR) tracks the CSI 300 Index, which holds the largest and most liquid stocks in the A-share market. It’s up 35% year to date and 129% for the past year. It charges 0.8% of assets for expenses.
Market Vectors ChinaAMC A-Share ETF (ARCA:PEK) also tracks the CSI 300 index but charges less: 0.72%. It’s up 39% year to date and 132% in the 12 months. The big difference is that ASHR is more liquid and offers a 0.2% yield, while PEK offers none.
As liquidity improves in July, David Goldman, managing director of investment firm Reorient Group, sees a market recovery and a move back up beyond the 5,000 level for the Shanghai Composite.
“Economic fundamentals are clearly improving, and so are regulatory incentives for stock market growth,” he wrote this week.
Originally published in Investor’s Business Daily.