It Could Be Time to Call on China ETFs

It’s been a wild ride for Chinese stocks, particularly those of the growth variety, and the related exchange-traded funds dating back more than a year.

Over the past year, the widely followed MSCI China Index is down 32%. Much of that decline is attributable to a scorched earth regulatory campaign waged by the Chinese Communist Party (CCP) against consumer internet and other web-related companies in the country.

Adding to the pressure are ongoing geopolitical tensions between the U.S. and China – the world’s two largest economies. While it’s too early to tell, there may be some thaw on that front and it be efficacious for some previously high-flying China ETFs.

Last Friday, the Securities and Exchange Commission (SEC) announced the Public Company Accounting Oversight Board (PCAOB) reached an accord with the China Securities Regulatory Commission (CSRC) and the Ministry of Finance of the People’s Republic of China. That paves the way for U.S.-listed companies based in China and Hong Kong to be audited and investigated by U.S. regulators.

“This agreement marks the first time we have received such detailed and specific commitments from China that they would allow PCAOB inspections and investigations meeting U.S. standards,” said Securities and Exchange Commission (SEC) Chairman Gary Gensler in a statement. “The Chinese and we jointly agreed on the need for a framework. We were not willing to have PCAOB inspectors travel to China and Hong Kong unless there was an agreement on such a framework.”

That could prove important to a variety of China ETFs, including the following group.

KraneShares CSI China Internet ETF (KWEB)

Few China ETFs have been affected by China regulatory wranglings and delisting fears on par with the KraneShares CSI China Internet ETF (KWEB). However, fears about KWEB members being removed from major U.S. exchanges may be overblown and those departures could be years away, if they materialize at all.

“There is a long runway before this becomes an immediate concern,"according to KraneShares research. "Under the current law, these companies have a three-year window to become compliant. Companies will have the opportunity to comply in their annual reports for fiscal years 2022, 2023, or 2024.” 

Worst case scenario for many KWEB holdings is that those companies move to listings on the Hong Kong Stock Exchange (HKSE), thereby enhancing the liquidity of what’s already one of Asia’s most liquid listing venues. Overall, KWEB could be offering favorable risk/reward at current levels.

Emerging Markets Internet & Ecommerce ETF (EMQQ)

The Emerging Markets Internet & Ecommerce ETF (EMQQ) isn’t a dedicated China ETF, but it allocates over half its weight to Chinese stocks, all of which are internet names. That confirms the ETF has been a battleground of sorts for more than a year. However, signs are emerging EMQQ could be ready to reverse course for the better.

“The Chinese tech space went from relatively unregulated to one with better defined rules, especially around data privacy," notes EMQQ Global founder Kevin Carter. "China isn’t alone in this effort and we believe you’ll see higher regulatory pressures world round in this space. With more defined rules in place, we expect the Chinese tech firms in EMQQ to adjust and move forward. China is certainly not trying to destroy one of its most innovative sectors. Just better regulate it.”

Should an earnest rebound in Chinese growth stocks materialize, expect EMQQ to be a leader in the ETF category and that comes with many of the fund’s holdings trading at discounts relative to comparable U.S. stocks.

WisdomTree China ex-State-Owned Enterprises Fund (CXSE)

Like the other China ETFs highlighted here, the WisdomTree China ex-State-Owned Enterprises Fund (CXSE) is heavy on many of the most embattled of Chinese communications services and consumer cyclical stocks. As such, near-term downside risk with this fund may not be as significant as what investors saw over the past year.

Positioning for a China equity rebound may be best executed by favoring growth stocks and avoiding lumbering, growth-capped state-owned enterprises (SOEs). In the efficient ETF wrapper, CXSE does just that for investors.

"We believe our non-state-owned strategy is still the best way to invest in any emerging market, not just China, and we look forward to having deeper discussions with you," noted Liqian Ren, director of modern alpha at WisdomTree, in a recent blog post. "If you are considering a benchmark Chinese equity allocation, the impact of politics and regulations on companies is unavoidable, in many ways similar to other emerging markets. But China will get more attention than most, just for the size of its economy.” 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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