China Installs Welcome Sign

If a client portfolio already owns Chinese stocks minus A-shares, how do advisors complete their exposure to the Chinese market?

Adding an onshore equity ETF like our KraneShares Bosera MSCI China A (KBA) provides exposure that likely will be added to broader indices at some point in the future. One benefit of the onshore market is an exceedingly low correlation market to global equities. KBA has one third the correlation to U.S. stocks versus frontier markets. We worked with MSCI to hold the specific slice of the onshore markets that would be added to their indices with an onshore inclusion. We recently listed the KraneShares FTSE Emerging Markets Plus ETF (KEMP) for investors looking to embed the onshore markets within a broad EM strategy.

The eCommerce and social media investing trend is a global phenomenon. How is China doing?

China has gone from having virtually no Internet users to having the largest Internet population globally with over 600mm users in fifteen years. As remarkable as that is, less than half of the population uses the Internet today. China is leapfrogging over the big box retailer stage as increasingly retail sales taking place on line especially on mobile devices. An important reason for the adoption of e-commerce has been the rise of smart phone as the primary source of entertainment in China.

While comparisons to their U.S. equivalents are easy, an investor should recognize the three large players, Baidu, Alibaba and Tencent, are Internet ecosystems offering a broad menu of services and applications. These companies are becoming financial-technology companies as they increasingly offer banking and asset management offerings. Based on their knowledge of who pays on time and who doesn't, Alibaba created China's first credit rating service. Alibaba also allows buyers and sellers to park cash in what has become China's largest money market fund. In many instances, the large players have partnered with medium and smaller players. There are also companies going alone such as C-Trip, an online travel company.

How important is currency diversification when it comes to international investing?

Over the last seven years, the United States' equity markets have enjoyed a superb run accompanied by a very strong dollar. The vast majority of non-U.S. investments have been hurt by this strong dollar regime. China stands out as the Chinese companies listed in Hong Kong trade in Hong Kong dollars, which [are] pegged to the U.S. dollar. Onshore Chinese equities trade in renminbi, which has actually appreciated over 10% versus the dollar in the last five years while being the lowest volatility EM currency. The RMB actually has a substantially lower volatility than the British pound, euro or yen due to large foreign currency reserves that can be deployed to stabilize the currency.

Many expected the RMB to depreciate as a stimulus to Chinese exporters. In early March at the National People's Congress, several senior officials including Premier Li very vocally stated the RMB would not depreciate and would remain stable. The Chinese know 2015 is a review year by the International Monetary Fund for currencies to be designated a reserve currency. Reserve currency designation allows the $7 trillion in reserve bank assets to invest in investments denominated in that currency. There is virtually no RMB exposure in investors' portfolios. Remember Chinese companies listed in Hong Kong are in HK dollars. The RMB denominated onshore equity market is excluded from such indices. China's fixed income market is excluded from all EM indices entirely. If the RMB is designated a reserve currency we expect the currency to appreciate. There would be virtually no benefit to investors who hold no RMB denominated assets.

Knocks against investing in China include corruption, lack of transparency, and asset bubbles. How can advisors navigate these risks?

China, like any investment, should be held within a diversified portfolio. By partnering with two of the largest Chinese mutual fund families, we have seasoned investment professionals experienced with the onshore Chinese markets. Many of these professionals have worked or been educated in the United States and bring our focus on operational excellence with them. Charles Wang, chief investment officer of Bosera Asset Management, was the director of research and lead portfolio manager for a large Boston based mutual fund family prior to moving back to China. David Zhang, CIO of E Fund Asset Management Hong Kong, worked for several U.S. mutual fund families prior to his move home. Their local insights are different than what the average U.S. investor reads about China.

We look to be diversified within our portfolios as well. Within KBA for instance, we hold over 300 stocks with our largest holding not being more than 2% of the portfolio today. Investors today hold one and a half times more exposure to Switzerland than China despite China having an economy ten times larger. The Shanghai and Shenzhen Stock Exchanges have $7.7 trillion of market cap, which [is] 10% of the world's total. Despite this, China comprises only 2% of global indices. We believe investors globally are under-allocated to the world's second largest economy. Through our partners and collaboration with China based research firms, we endeavor to provide a balanced perspective of China's economy and capital markets.

At what point will China officially graduate from emerging country to developed market?

The definition of emerging market includes a number of factors from index providers like MSCI and FTSE though GDP per capita is at the top of the list. Over the last 30 years, China has undergone a massive population shift from rural to urban. In 1980 less than 20% of the population lived in cities versus just over 50% today. The growth of cities provides people with proper housing, electricity, running water, and many standards of living we enjoy here in the U.S. versus the rural, agriculture based economy. Urbanization has led to hundreds of millions being lifted out of poverty. China has a goal of 75% urbanization rate, which means hundreds of millions more will move into cities in the decades to come.

With a population of 1.3 billion, meeting the GDP per capita criteria to be designated a developed market is decades away though the trend is firmly in place. From my time spent in China, if there is only one message I would convey about China [it] is the will and desire of the people to lift themselves up and provide their children a better life. Going back to where they've been is not an option.