ETF Edge - Investing in China & Rising Regulatory Risks

Episode Date: August 2, 2021

CNBC's Bob Pisani spoke with Kevin Carter, Founder and CIO of EMQQ, Perth Tolle, Founder of Life and Liberty Indexes, and John Davi, Founder and CEO of Astoria Portfolio Advisors. They discussed the great China debate – with China doubling down on new rounds of regulation, should investors get in the game or go running for the hills? Plus, in the ‘Markets 102’ portion of the podcast, Bob will continue the conversation with Kevin Carter from EMQQ. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, supporting the innovators changing the world. Invesco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange-traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis. We're breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show will be plunging into the great China debate.

What China doubling down on new rounds of regulations should investors get in the game? or run for the hills. We'll bring you both the bull and the bear case here. And here's my conversation with Kevin Carter, the founder and CIO of EMQQ. Perth Toll is the founder of Life and Liberty Indexes. John Davy is the founder and CEO of Astoria Portfolio Advisors. All right, Kevin, you've told me repeatedly. Stay focused on the emerging market consumer.

What's the broad thesis behind EMQQQ and why do we need to keep staying focused? Not just on China's emerging market consumer, but on emerging market consumers all the world. Sure. Well, when you really break down emerging markets, the thing that's emerging are the people. You've got billions of people, 85% of the world's people, 90% of the world's people under the age of 30. So emerging markets are both the world and even more of the future. And the people are moving on up, and they want stuff. They want more and better food, clothing, appliances, entertainment. They want their kids to go to college and they want a car. And that's the story. It's well documented. And it's what everybody should be focused on in

emerging markets. But what makes the story even more exciting is that all of those billions of consumers are getting two things that we take for granted. First, they're getting a computer for the first time. It's not on their desk. It's in their pocket. And it doesn't have an Apple logo. A smartphone. A smartphone. A supercomputer that's in their pocket. And it's running on Android, and it costs 50, 60, 80 dollars and getting better and more affordable every year. And it's also bringing with it the third megatrend, which is the internet, something I've had since 1995, first on a telephone line in the Marina District of San Francisco. Now the internet shows up in my pocket. But the reality is most of the world was never wired. So all of those billions of people

getting their first computer, their first internet access, and importantly, because they don't have a bank account with a debit card, they don't have a cable television on the wall, and there's not a target store. They're leapfrogging to digitize consumption. and are in many ways more digital than we are. So it's pretty simple. The consumer plus a smartphone plus the Internet equals massive revenue growth. But I want to turn to you, John, here. You invest all over the world.

And where do you stand on China? You've repeatedly sort of been non-ideological on China and talk about it more as a value play. Is that the right way to look at it? Don't worry about the ideology and when to get in and when to get out? I think so, Bob. And I've always told our investors, like China's a long-term play. There's going to be a lot of bumps in the road.

but it's very volatile. So we have a strategic overweight to China. We've had it. I've been on the show many times. I've liked China. I think what we're seeing now is par for the course. There's always regulatory risk investing in China. I think right now, you know, there's value in there.

I think there's more downside. But I think long term for everything that Kevin talked about, you know, there's a way to monetize these billions of people in broad emerging markets. And China is a good way. China has had low correlations to the U.S. The last month, U.S. has been rallying. China's been going down, that's good when you own a globally diversified portfolio of stocks.

But there's always been regulatory risks, but what we've seen recently is upping the ante. I mean, this is more than just normal. Chinese government has been going after a number of industries. Are you really arguing that this is just par for the course at this point? Well, if you look over the last 10 years, there's been a series of regulatory tightening policies in China, you know, across a number of different sectors. is each time that sector gets hit 20 to 50%. So I think what we're seeing now is, you know,

it's extreme volatility, of course. But, you know, we're also seeing some signs of bottom fishing. The K-Web ETF has taken in $2 billion of inflows over the last month. I think there's, you know, some people that are looking at, you know, value in the Internet sector. Yeah. Perth, what about that argument? Can China be investable as a value play, as John has been implying? Yeah, I think the fact that China is now being.

seen as a value play, it's a testament to how much we underestimated the risks and how people are now repricing that risk. I mean, let's be clear. I mean, China had a lot of growth over the last 30 years. That's undeniable. But that growth came from an increase in freedom levels. The government steps back and allowed people to be more free. And that caused this tremendous growth in the country. And if they do that again, then absolutely it's a value play. But right now, that regulatory risk is going the other direction and going the other direction fast. And that pendulum is swinging the other way. You see their favored sectors like tech getting hit hard. And that's just not something we've ever seen before. This government is going to be in place for a long time unless there's

some upheaval and the crisis that kind of overthrows them. And so this is not a place where we want to be investing. We don't want to give up the opportunity risk of all the other emerging markets that have the conditions on the grounds for growth and wealth creation and have free people in free markets. So we're not going to give up that growth. I mean, if you look at China in the past, right, last 10 years, let's look at something large-cap like FXI. That fund has returned about 25 percent over the last 10 years, chemoatively. Compare that to their neighboring markets. South Korea has returned twice that. Taiwan has returned 170 percent in that time period. So I think China, yes, they've had some growth in the past. That growth was due to the government

stepping back. Now you see the government going to the other direction, and that is now a growth story of the past. Yeah, and so you're invested in big, global, mostly tech companies outside of China. I see Taiwan semi, obviously in Taiwan, Samsung, Media Tech, Hanai Precision, another company that's based in Taiwan. So your argument is still stay away from China and that you can get just as much, if not better, growth by investing in companies outside of there that are more freedom-weighted, as you like to argue. There's your weightings here by your country, and you can see there's obviously nothing in

mainland China. Yeah, absolutely. So we believe that growth in the next decade is to be found in countries that are more free in the emerging markets. Yes, they're going to do trade with China, and we don't penalize free trade. Trade is good, and that's part of their economic freedom. But these are not companies that answer to the Chinese state. These are not companies where the state, can come in overnight and wipe out all of your value because you're now required to be a nonprofit like we saw with the edutect companies last week. So this is not a tail risk that we're willing to take and freedom waiting solves that problem and eliminates that risk for investors. You're still going to have some indirect climate exposure through trade and you'll have that even in the S&P 500.

But there's no need to double up on that. So Kevin, what do you say to Perth's argument at this point? They're all essentially state-owned enterprises. It is, Is Alibaba or JD-Com essentially a state-owned enterprise? I mean, I've heard Perse before whatever happened to Jack Ma. I mean, is he a state-owned enterprise? I'm not being rhetorical, but you get where she's going with this. I understand. But this is sensationalist comments and thoughts.

The idea that China has done well because they gave people freedom and they had capitalism for the last 30 years, and now they're going to change it. I think it's that type of talk and the fear and panic that makes an incredible opportunity. Chinese government understands capitalism. I'm with Charlie Munger and Ray Dalio on this. They know that if people make money, that's good for the country, and they'll continue to allow that. And this series of regulatory issues is just normal management of the country. It's the financial

system, it's monopoly rules, and these are not unique to China. Every day, you can see the similar attacks here in the U.S. on our big tech companies, Europe, It seems like every month Google pays billions of dollars in fines. So this is about government getting its arms around the power that a lot of these technology companies have, and making sure that they have rules and regulations in place that are for the good of society. Perth, is this going to discourage people from investing outside the United States in general? Is this good or bad news? I mean, you know, we've talked about how the international investor in general has been on their heels for the last 10 years,

they're going to be even more on their heels defending themselves about being invested overseas. Is there anything good or bad that comes out of this? Yeah, unfortunately, I think this would encourage investors to turn negative sentiment toward international investing, especially emerging markets, because these are the very issues why people don't invest in emerging markets in the first place, a lack of transparency and the political risk. We try to eliminate that risk by doing freedom waiting. And so I think we do solve that problem for investors,

But absolutely, especially in a time when U.S. valuations are so high, you don't want to be discouraging people from investing overseas. So unfortunately, I think that is what's going to happen here, especially since China makes up 40% of most emerging market indexes. So, John, does this regulatory thing with China regulators and U.S. regulators sort of upend global investing? You and I have been doing this for a long time. And for the last 15 years, we keep talking about the U.S. consumer is allocating more money to investing overseas. It's easier to do because of ETFs and the growth of indexing. So you sit there and you say, okay, if I'm in the all-world index, China is 5%. And I can buy that as an ETF easily.

If I'm in an emerging market index, China might be 40%. I'm including Hong Kong and part of China. And everybody just said, okay, that's the way the world works. Does this upend any of that? Does this say, well, maybe we should not think about investing globally by market capitalization. We ought to think about it in another way. I'm just thinking if there's something happening that's a sea change, or perhaps, as he is suggesting, maybe it's a lot, much ado about nothing.

Maybe we've seen this regulatory crackdown before, and we ought to just keep continuing investing. I'm trying to figure out what should the investor be thinking about this. Should they change the way they're investing? Well, I think, you know, the last 10 years you've had an incredible run in U.S. markets. You know, the rest of the world has underperformed. You know, U.S. is a higher quality of markets, got better balance sheets, you know, it's got better fundamentals. There's periods of time where emerging markets or developed markets will outperform. I think investors and other financial advisors have been very discouraged over the last 10 years because you've had a one-way trade where it's been mostly U.S. outperformance.

I still think the right thing to do is to have a globally diversified portfolio and have some exposures to emerging markets and China and other developed markets. I know it's tough, but you really want to have a long-term time horizon. Yeah, and I know we were talking before. Kathy Wood is reducing, of course, of Arc is reducing her exposure to China stocks. And then there was an announcement just this weekend. There's a short ARC ETF filing. You can actually be able to short that. What is that portend for thematic investing when you could get a short ARC ETF filing?

Well, first, I'm a big fan of Kathy Woods. I think she's done an incredible job for the active management industry. I see a lot of Me Too products. people trying to replicate her success. So definitely pulling for her. What I would say is that I think all investors should have the ability to hedge their exposure. So there's like $2.5 billion of short interest in the ARC-K ETF. And if you're a traditional investor, you're going to go on Schwab or TD and trying short,

you're going to play probably exorbitant borrow costs and fees. So to be able to have an inverse ETF, I think it's a good thing. Pro Chosha's direction have done a pretty good job, you know, over 10, 15 years. in terms of leverage in inverse products. So I think it's a good tool for people to have in their toolkit. Kevin, I just want to go back to the idea of how tough it is to be a global investor at this point.

If you're an international fund advisor, you've been underperforming for 10 years now. I just put up some statistic. The SEP is up 240% in the last 10 years. Even Japan's only up 180%. MCHI, the main China ETI, is up 35%. The EEM, one of the largest emerging markets, essentially flats, up 7%.

That's a tough, every year you're basically saying, why am I allocating internationally and I'm behind? And now you have this additional factor. There's no doubt. Emerging markets have been a huge disappointment. The 14-year return for emerging markets is basically zero, and with a lot of red in the middle of just getting your money back. But you don't, any emerging markets, you can't buy the broad indexes. The broad indexes are broken because of heavy exposure to the legacy economy. The exposure to the state-owned banks, the oil companies, the corruption.

People are talking about the risks of China. The last two presidents of Brazil are in prison for basically stealing your money if you're using EEM or VW. And so what we've done is create really the tip of the spear, not just of growth in emerging markets, but in the entire world. This is the fastest growing sector, I think by far in the world. And investors in this particular sector have done very well. It's especially relative to every other emerging market flavor. You know, Perth, Kevin does bring up a good point.

You might have freedom in many countries of the world. In theory, you have it in Brazil, too, but you can get just as much corruption of people stealing money. You know, you keep bringing up Petrobras. I know look what happened to that company, where companies came in, people came in, and is it too strong a word to say looted the company? It's exactly what they did.

And it was the last two presidents, and about a third of their congresspeople, we're systematically stealing billions of dollars from Petrobras and thus people that own the vanguard and Schwab. And yet, Perth, there's a reason for us to continue to support freedom and liberty because, well, look, here, as John likes to say, you know, quality, why are we the highest quality market in the world, John? Because of the way we conduct capitalism? What is it makes the U.S. such a high quality return? Better balance, better regulatory framework, more clarity and data. Historically, the way U.S. company has been run, relatively. to the rest of the world. That's why you'll pay a premium in terms of valuation,

and that's why it'll tend to be richer compared to merger markets. So Perth, I'm going to leave you with the last word. How do we get the rest of the world to be the same high-quality and have the same high-quality metrics that John is talking about? What's the right path? Yeah, I think John is exactly right. It's our rule of law that allows us to be a successful capitalist marketplace. And without that rule of law, you just cannot operate efficiently.

So we're talking about things like corruption. Corruption and freedom are inversely correlated, and there's a direct observable, positive inverse correlation with those two things. And so if you're going to try to avoid the companies that cannot operate efficiently because they have to put state interests first, and if the state is corrupt, then there's nothing you can do. So we're going to try to avoid those companies, and we're going to try to invest in the places that have the freedom to operate

in the best interests of shareholders and other stakeholders besides the government. And we think that's where the growth is going to be in the next few years. And I'm glad that Kevin got to arrive the Artego's bubble there, but I think it's time to switch into other emerging markets. And fortunately, his fund is an emerging market fund, not a China fund. So he's able to do that. So I think we'll all be successful here going forward. Okay, very well said.

And we can always count on you to bring out the fundamentals of the capital system that we all believe in. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market's 102 portion of the podcast. Today we'll be continuing the conversation with Kevin Carter from EMQQ. And Kevin, thanks for staying with us. Can you make an argument at this point that what looks like China's attempt to essentially take control of private companies in China is really a very, reasonable attempt at regulation, and maybe we're making a little too much of all of this? How are you looking at it? I look at it right now as an incredible buying opportunity, because most of the things that people are scared about, starting with the Ant Group IPO in November, also monopoly rules that were

brought to the table in November, all of the things that I've seen ultimately give me strength that the Chinese government knows what they're doing, they're smart, and they need regulations, just as every other advanced economy has. And to me, everything they've done is very sensible. And now, I understand that forcing the online education business to become not-for-profit, that gets very close to people's biggest fear, which is the Chinese government's going to take these companies. But I don't think that's what they did.

And more importantly, I think that the social problem that exists there with this intense education focus, I think it needed to be addressed. And I think it's unfortunate if you were an investor in the online education companies that are affected. But we didn't have any exposure there. We had 0.05% exposure to the online education space in China. But doesn't this tell you if you're an investor at all, somebody could come in and say, you know, at any point, We want more regulation. I mean, I know that to a certain extent, to a certain extent, you could do that in the United States.

Yes, you're right. But this was pretty interventionist in the education space. Now, I know your argument. I've talked to you before about this, that people were basically getting ripped off in China. They were spending exorbitant amounts of some, and they were taking advantage of the fact that every other family's kid was spending, they were spending a fortune for private tutoring, and it got out of hand. Yes. Obviously, the government was worried about this. They should have been.

It was a big problem. It was a pain point to the vast majority of Chinese. And I think there's no doubt the Chinese population, they appreciate these moves, although clearly U.S. investors didn't. And really, in particular last week, went into serious panic mode. And, you know, as we say in Omaha, you pay a high price for a cheery consensus, and you'll always get your best values when things look terrible. And when I look at the situation,

there's been some damage to the value of the Chinese Internet sector, particularly in the Fintech space, where everything's probably lost a third of its value. But the Chinese government doesn't want to kill the growth. They don't want to kill the capitalist instincts of these companies, but they have to maintain order and regulations are how they do that. And, again, that's not a China situation. That's happening all over the world.

I mean, I guess the point is, Your point seems to be well. There's, look, reasonable regulatory concerns that the Chinese government has had. These companies have grown. They've lost control of them. In the case of aunt, I can understand. You can make a bank loan application essentially on the chat service, essentially. That's a non-bank bank, essentially, so I can understand why that would be a concern to the Chinese government.

but how do you stay invested when we may not know next year there's going to be some other aspect of this? Do you stay invested? It seems very difficult to figure out. Well, look, again, when things look bad is when you get your best values. And ultimately, over the long term, earnings equals value and growth of earnings equals the growth of value. When there's no sector in the world today that's growing its earnings and revenue as fast as the emerging market's Internet space, which includes China as the largest part. But again, if everything's relative in the world,

I mean, so China's government and its regulations are risky relative to what? Relative to Petrobras, which we discussed and the corruption that's taken that whole country down, relative to Russia, right? Relative to the Indian government, I mean, India might be democratic, but their moves against Amazon.com, for example,

in the case of Future Group versus Reliance Industry, I mean, this is... Yes, I agree with the point. Just because you're democratic does not make you not interventionist necessarily. Yes. I agree with that point. Yes. So the idea here is get used to more regulatory control of some sort.

Your position is the Chinese government is exercising due diligence, essentially, to try to control sectors of the economy that is getting out of control. They're trying to make sure they have the appropriate regulations in place, and and that those regulations are adhered to and enforced. And that wasn't happening as much as it needed to. The fintech space we talked about, the monopoly situation was right in the open. I mean, Alibaba's pick one of two policy whereby they would tell international vendors or manufacturers. If you want to sell on our platform in China, you can, but you can't sell on anybody else's platform. And so these things needed to be addressed as a $2.9 billion fine paid, but they moved on.

but they'll continue to enforce those types of rules. As we do here, the difference is there. They can do it in a very quick and efficient way that in many ways has a lot of advantage versus the lobbying we would have here, the hearings, the years of special interest groups and dragging these things out. China has a real advantage in some ways

and regulatory speed and efficiency is one of those things. Yeah. I'm going to leave it there, this isn't going to go away. I can tell you that I've gotten a lot of interest from the viewers about whether or not they need to change the way they're looking at things. The answer seems to be, for the patient long-term investor, the growth of the emerging market consumer story has not changed. Essentially, emerging market consumer plus a cell phone, plus the internet equals big revenue growth, and it will continue. That underlying story seems to be unchanged. That story is

unchanged and it has produced what I am quite confident is the fastest growing sector in the world, not just today but ever. I mean, the last 11 years, the emerging markets, internet sector, has revenue growth of 37% a year on average for over a decade. And so this is where the growth is and there's going to be ups and downs and there's going to be fears. And in the case of China, there always has been cheers and there are fears and there always will be fears. And you're going to find your best buys when those fears are highest, but I think that for long-term investors, those fears are unwarranted long-term. Kevin Carter runs the emerging markets, Internet and Internet and Commerce, ETF, excuse me, Kevin, EMQQ is the symbol there. They invest very heavily,

obviously, in the Chinese consumer. Kevin, thanks very much for joining us. Thanks, Bob. That's it for today. I'm Bobazzani. Thank you for listening. And make sure you tune in next week. And in the meantime, you can tweet us your questions or topic ideas at ETF Edge. See you. B.C. Invesco QQQ believes new innovations create new opportunities. Here's the greater possibilities together. Learn more at investco.com slash QQ. Invesco Distributors, Inc.