China ETF

ETF: The index investor’s guide to China

In ETF Blog, Latest by Kristia van Heerden

ETF strategist Nerina Visser says local investors can expect upside through index investments with Chinese exposure over a five- to ten-year period. While slowing growth in China has some worried, Visser points to a supply and demand issue that could prove lucrative to those who act now.

“China is the world’s second-largest economy and on its way to becoming the largest. Because of former government restrictions on foreign investment, the Chinese economy is severely underrepresented in global indices, making up less than 10%,” says Visser.

Now that foreign investors can gain access to companies that operate on mainland China through shares traded on the Shanghai and Shenzen exchanges, global indices have to catch up on China’s weighting.

“That change is going to result in major structural demand for Chinese companies,” Visser says. She points out that the structural investment case should be differentiated from a fundamental investment case. “A structural point of view says there’ll be a lot of demand for shares from international investors to gain exposure they weren’t able to get before.”

While many DIY investors have become less certain about the Chinese economy due to slowing economic growth there, Visser says the Chinese economy still offers growth rates two or three times that of developed markets.

“The Chinese economy is slowing from high base and still getting much faster growth than anywhere else. The type of growth is changing from infrastructure to consumer growth. Exposure to companies in consumer space, like Naspers, and tech companies will give you better performance than old-school companies.”

Locally, Naspers’ stake in Chinese company Tencent has proven remarkably lucrative to shareholders and vanilla index investors alike. Naspers, which currently makes up 17% of the market capitalisation-weighted Top 40 index, gives Top 40 investors around 10% exposure to its Chinese business.

While it’s certainly possible to gain Chinese exposure through an index investment that includes a high percentage of investment in Naspers, it’s not the ideal way to get in on the action. Visser points out that Tencent is only one part of the Naspers business and investors will gain exposure to other companies within the index that might affect performance. Those who choose to go this route can consider the INDI25 ETF, which offers greater exposure to Naspers than the Top 40.

China in your ETF portfolio

Locally, the easiest way to access the Chinese market is the Deutsche Bank MSCI China Total Return exchange-traded note (ETN). ETNs differ from ETFs in that the product doesn’t hold the underlying asset and rather invests in the price movement – in this case share prices of the Chinese companies represented in the ETN.

While ETNs are often considered more risky than ETFs because there’s no underlying asset, Visser points out that the product is no more risky than holding a savings account. In fact, she says, much more risk comes from the volatility of the underlying asset than the product.

The downside to this seemingly clear investment solution is that you’re not allowed to hold it in your tax-free savings account. If you were hoping to get your fix the TFSA way, there’s no one elegant solution.

Aside from Naspers exposure via the INDI25, Visser recommends a global property ETF because of its exposure to the Asia-Pacific region. Expect your Chinese exposure to be diluted at best, she warns. While there’s talk among some providers of converting ETNs into ETFs, Visser is not holding her breath for a conversion of the Deutsche Bank ETN.

Finally, she says volatility is expected in the Chinese environment, so prepare to be locked in for between five and ten years. “I remain a fan of regular monthly contributions for rand cost averaging,” she says.

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