ETF Edge - Rethinking investing in China 10/10/24

Episode Date: October 10, 2024

Two new approaches – one hyper-local and the other hyper-specific – attempt to navigated the pitfalls of generic investment in China.           Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by Invesco QQQ, proud provider of access to innovation for the last 25 years. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you are 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, and breaking down what it all means for investors. I am your host, Bob Pisani. Is China uninvestable, or is it buy everything? Which is it? We're attempting to figure that out. Here is my conversation with Dave Mata. CEO of Roundhill Investments, who has just launched a new China ETF, and Jason Su, he is the founder and chairman of Brailleant Global Advisors, which focuses on investing in China and emerging markets. Dave, you launched the Magnificent 7 ETF a year and a half ago. Boy, that was perfect timing.

And last week, you essentially launched a China version of the Magnificent 7 ETF. I know you're calling it the China Dragons ETF, nine of the largest and most innovative Chinese companies. I want to talk about that later. But despite these, stimulus hopes that we're talking about in China. The stocks in China, the indexes are trading at the same levels they were 17 years ago in 2007, 17 years ago with no gains. Is there any argument to be made that China is suddenly a better investment now than it has been in the last 17 years? No, you're absolutely right.

If you look in the rear view mirror, China's been a really difficult market to invest in. It's been dead weight in Port-Boy, as your point, it's really moved nowhere. But what's important to know about China is, again, the second largest economy in the world, second largest equity market in the world. So we don't believe investors should actually ignore this as part of its overall portfolio, particularly in light of the fact that the Chinese economy is really one that is dynamic and growing,

but it faces a challenge. What's different now is that the Chinese authorities at this point are putting a huge amount of stimulus To date, it's only been on the monetary side, focus on the stock market, but there's expectations for a lot more, especially on the fiscal side and the structural reforms that can really make this market more impactful going forward. Jason, the same kind of question to you. The S&P 500 is up 270% since 2007. China stocks, the indexes are essentially nowhere, zero. So can you explain to the viewers why, has China been such a disastrous underperformer on a global level? And is anything happening here, including these vague stimulus hopes that would change that poor performance? So Bob, first and foremost, this is the difference between an efficient market and inefficient market.

The US is very efficient. So you're going to do just fine holding the magnificent seven, the SMP 500. But for China, you need to actively manage your portfolio mix, right? If you just buy the index, you will experience a lot of the index. will experience a lot of volatility, a lot of ups and downs, but really no positive trajectory. That's because you need to constantly rebalance your portfolio, aiming your portfolio in the direction of where the stimulus spending might be in a particular fiscal cycle, aiming your trajectory in where the industry is going, and there are very volatile industry rotations in China.

Had you done all of that, you actually would have experienced quite a nice right in a more actively managed portfolio. Now talking about actively managing it in the direction of stimulus, I think Dave is absolutely right. The Chinese government is now spending two trillion in the first tranche and is expected to go up to about 10 trillion by the time they're all said and done. And in fact, they've signaled there's no upper limit to how much they'll throw at the economy to make sure it grows at a 5% real GDP target. And I think that's quite exciting. The government's telling exactly what it is going to do. And this Saturday, it's going to tell you, In fact, where the money is actually being aimed toward, and you just have to, in a way, follow the government's money, right?

It's like we used to say, follow the Fed, don't fight the Fed, in this case, follow Beijing, don't fight Beijing, and I think you're in for a pretty good bull market ride. You know, I appreciate what you said, Jason, but I still see this as a very tough sell. We had stimulus before in China, but we still have overall poor performance. And I think more importantly, China is perceived to be much less friendly to global investors. Because of the policies of Xi Jinping, the head of China, if you look at the investment landscape, the China consumer is over-invested in real estate, they seem underinvested in the stock market, and they're very heavily invested in personal savings.

So it seems to me like we're going to need a lot more than stimulus. I mean, doesn't China seem to need a restructure of the whole economy? But that seems like a tall order under Xi Jinping, doesn't it? I mean, there's something missing here, isn't there? Bob, you're absolutely right. There are two things, right? And if you're focused just on the stock market, there's, of course, the dry powder, how much can be deployed, and what will it take to move all the money into stock market? Right now, you know, estimated there are about 20 trillion. This is not renting B. This is U.S. dollar, 20 trillion equivalent in dry powder, cash in the bank, waiting to invest. The fact that they haven't invested is, of course, a confidence issue. So on the one hand, you've got a lot of money, very well,

weak confidence, but that could all turn into potential for the market. But I do want to talk about the other point you may, which is the underlying economy, right? Because ultimately, the stock market is more than just a confidence game, right? You do need the underlying economy to perform. And I think this is where there's a lot more weight and see, right? The government will spend money, throw money at it, but we know ultimately it can't be just government spending, right? There has to be really healthy, strong private sector, investing from the corporate side and

spending on the consumer side. And I think you're right, that remains to be seen. Is the stimulus big enough to kick start a virtuous cycle? And we'll have to see. I don't mean to keep belaboring this point, Jason, but what's going to change here? I mean, it seems like you need a fundamental restructuring of the economy. Xi Jinping does not like capitalism. That's what kind of the underlying premise here.

How are you going to change this to suddenly make it a more? investor friendly, more open, more transparent. This seems to be going against everything Xi Jinping is telling us at this point. Yeah, so I think, you know, the one thing that I have a slight different view versus others looking at Beijing is yes, you know, Xi Jinping does, you know, have his skepticism about the capital market, but he's also quite practical and wily, right? He didn't maneuver himself to the top position, not because he's, he's, he's is inflexible and unintelligent, but because he's quite savvy and can pivot. And I think he's probably taken his licks and realized that through Beijing's incredible

effort, right? It has struggled mightily at managing economy. It has to go back to what has worked for his predecessors, which is let the capitalistic competitive economy do its work for him. Because ultimately, for him to stay in power to be the legitimate, you know, grand leader, the economy has to perform. And I think he's tried one path, which is him micro-managing and working really hard and seeing almost no results. And I think he's now sort of recognizing.

And it's just like COVID, right? His initial policy managing COVID was unsuccessful. And then he said, that's got, I'm just going to open it up. I think he's hit that point where he says, look, really capitalistic competitive market is the way to go. I'm impressed you're saying that. I don't necessarily know if it's happened yet. I mean, the problem here is that everybody, my. self-included, thought when Xi Jinping came in, we were going to get sort of another version

of Deng Xiaoping, the great leader of the 70s and 80s who brought China out of the disasters of the 1960s and instituted limited amounts of capitalism. But we didn't. Instead of Deng Chau Ping, we essentially got Mao Zetong. And that's the problem the global investors are having. You're saying you think that Xi Jinping is starting to change? Is that your point here? Yeah, because what we're getting from Beijing, right, previously, Bob, you're absolutely right. He was dismissive of the stock market thinking that. In China, the stock market is more like a casino. So why should I care about what the stock market's telling me? But he was quite, sort of micromanaging when it comes to real estate thinking, oh, he's going to contain the real estate bubble through sheer force of sort of taking apart these big construction companies. I think he's come to realize that it's a very delicate system and this micro managing doesn't work. You know, it's been three years. of him doing that and the data is just telling him the old system works better. So I'm betting on the practical side of him is going to pivot.

I hope that you're right, but I'm still skeptical. Dave, chime in here. Somebody's wrong here. I know David Tepper of Appaloosa management. He was on our air. He said he's buying everything related to China because of the government support, the stimulus supposedly that's coming. But we have other people.

Ray Dalio says it's really difficult to invest. in China because Beijing is seeking to structurally move the country away from capitalism. So somebody's wrong here, Dave. Your thoughts? Yeah, no, I think, but you're hitting the nail on the head. The Chinese market has been full of controversy for good reason, because to your point, there was expectations of further broadening out and further opening up, and the opposite has happened. But I think Jason's point is a really good one, is that, that, that, But we're at the stage now where I think the authorities are recognizing the challenges that they have and they need to pivot and need to make changes. However, I do think investors who are looking at China need to be more conscious and careful.

There's still a lot of risks. The smaller companies are very opaque. There's questions that actually about connectivity with state-owned enterprises and who actually owns what. And that was really one of the reasons the thesis is behind Akkad and Kai Draggie. There is a lot of similarities between those stocks and the mega-semedic stem of stock here in the U.S. But for an investor, looking at China now, precision may actually be a benefit because they know exactly what they're going to have. These are large mega-competational companies with revenue stream that aren't necessarily as dependent upon this stimulus fully coming to the place, even if we know it's happening. coupled with the fact that the Chinese market and, of course, this is going to take this

time, is extremely undervalued. The other than the world, relative to the U.S., and the broader PM. So if an investor is saying, hey, I can embrace content with the past may not be perfect. It could be volatile, but I'm actually buying stocks and much more quite with the potential for outside earnings going forward, which is one of the reasons why I think the Chinese did come back. All right, Dave, briefly, tell us more about this new China ETF. It launched last week.

I mean, this seems to be based on the same principle as the Mag 7 ETF was based on a year and a half ago. But give us a brief summary of what that's about. Yeah, so the China Dragons ETF, the ticker in drag, VRAG, is focused just on nine companies. And these are the companies that we identified as having similar characteristics to the magnitude of the U.S. And so that by that I mean, not to accept the large liquid, but they have high earnings growth, high revenue growth, moats around their businesses. And what we believe, like we've seen in the U.S., is a winner-take-all environment, whether that's AI, cloud computing, growth of the consumer, names like Alibaba, names like Baidu, Kenshet, Kinduo-Duo, exhibit those characteristics. And that's why them and only them are in the Chinese revenue. Okay. Jason, you also run a Chinese ETF. I want you to explain a little bit about Raleance investment methodology. This is the first time Jason's been on ETF, folks. So I wanted to explain your methodology briefly. And for those who do want to invest in China, what should they be buying? Explain this ETF to us.

Thanks, Bob. So what Dave just pointed out in his ETF, there are a lot of names that are listed in the U.S. are listed in Hong Kong. my ETF, Racy, it's only the onshore shares, meaning these are stocks that global investors, Americans can't just buy listed on the New York Stock Exchange. So these are the local shares, local names that you would have to be a local Chinese person to buy easily or you have to register what is called a kind of a cross-border, QFIT quota, stock connect to buy these shares. Okay, so these are the onshore shares. And generally, the unsure shares paint a very different story.

When you look at what's traded onshore in China, tech is only about 11%. The other 90% would be in consumer, would be in, you know, white appliances makers, in online, offline retailers. And so it paints a very different picture because China is sort of a different part of its growth curve, right? Technology is important, but a lot of the higher growth stocks are actually people who sell water, people who run restaurant chains. Often they actually have a higher growth than even many of the tech names.

And so we're trying to help investors get access to these names that are less familiar. There's very little research, at least outside of China. And they may represent what is more of a thematic in the moment trade inside China that is not known to U.S. investors. Yeah, so I want to put up the list of what's in this ETAF because it's interesting.

The list is very diverse. Chow Mu Tai, that's the famous liquor maker, right? That's like the biggest liquor manufacturer in China, right? Quichau. Absolutely. Yeah. Mal Thai is, of course, the luxury alcohol in China, and it's about $400 a bottle. And when the economy is starting to kick into gears, it tends to be like a leading indicator

when people start to consume these luxury alcohols because they're hosting big corporate parties, they're going out to dying. And so there's a great indicator of the economy turning around. Right. And Pingon, of course, is a big insurance company. They bought stuff in the United States, too, a while ago, number of years ago, right? Famously, right? Did they buy the Waldorf Astoria? Who won't do you? Yes. Pingon is a big, it might be Pingon, one of the, its related subsidiaries. It's, you know, it's the biggest insurance company in China, heavily exposed to real estate in China. And so it's a way to play the real estate turnaround, given the big government stimulus to stabilize real estate sector. So this is two different approaches here. I mean, Dave is basically tech companies that tend to list here in the United States, too. And you have like A shares that are U.S. that are, excuse me, mainland China base.

It's really sort of two different approaches. I guess the average viewer sitting here saying, okay, I'm convinced I should put 5% of my portfolio in China. These are two completely different approaches to it, really. I'm just asking you. You both notice this? The viewer would notice. right? Yeah, no, but I think I think what's interesting here is that even though we're saying in some ways what could be viewed as opposites, right? So Roundhill is advocating and creating an ETF that provides

precision exposures to the market leader leaders. Jason's approach is focused on the local Chinese stock or the different growth curve. What we're both saying, though, is that perhaps the broad-based exposures that folks have thought of for China, whether it's the largest ETF or whether it's even some newer technology focused China, EPS may not be the right way going forward. So I totally agree that approaches are either more active, more selective, and I would put drag in that camp as well, just looking a different spin on it. And to me, again, because of all the question mark that we talked about with China,

uncertainty that is going forward, I don't think we can just rely on Broadway- whether to have exposure to Shanghai or Shenzhen companies are not anymore. Right. And Jason, I can already smell the emails from people who are saying, well, the problem with owning China A shares is it's not really a real capitalist market. It's not really a stock market.

The way we understand it because the viewers will say, I know people will email me. The government essentially controls these state-owned enterprises. Is that correct? And can you explain what a golden share is? People often message me that the government have golden shares, which meaning they have the ability to actually control ultimately what goes on in these companies. Explain how involved the government is in running state-owned enterprises and what is a golden share. Absolutely, Bob.

So first of all, inside China, I would say 50% by market cap, right? It's not 50% by name, but 50% by market cap. It means some of the biggest list of companies are state-owned enterprises. Then they're often state-owned banks, state-owned insurance company, big state-owned power and utility. Those are not super-exciting and generally in an active portfolio that I manage. You know, Dave would agree, will have low exposures to state-owned enterprises because, as Dave, as you mentioned, the government in these state-owned enterprises have the golden shares, meaning they might flow shares, and U.S. investors could buy them and you'll receive dividends, but the government has more voting power than you do.

But that's not very unique, right? In the U.S., I think if you think about meta, Facebook, and Mark Zuckerberg has golden shares in a way that he, while being a very minority shareholder, has the majority of control. This is true in China with these golden shares. It just means when it's a big state-on-enterprice, the government, even though it might be a 20% shareholder, would have the majority control right. Again, we're quite careful in terms of oftentimes avoiding or be extra cautious with state-a-old. own enterprises because again sometimes they're just big dividend payers but there's not a growth because of the government intervention so your point is so for example is you have a company where the government owns 20% of the float by market

capitalization but they have 70% of the voting power is that your point you see to be drawing analogy it's kind of like met on mark Zuckerberg I'm not entirely sure that's the same thing necessarily though or it's necessarily that benign is this true by the way of private so-called private companies, for example, Alibaba or some other company that is not a government-owned enterprise. So in the case of Alibaba, interestingly, Jack Ma has the golden share, meaning I think Jack Ma has 4% of the company, but he has majority control. So it's similar from a corporate governance that if you're concerned about, but yes, the same concern. But Bob, you are right

in a sense, like, you know, you would believe Jack Ma to be highly competent, so you might want him to have the golden shares to have the control right where you might say well you know Beijing is Beijing really the best person to be running even if it's a big state all enterprise should Beijing have you know 90% 80% of the of basically controlling boats right right and and Jason this is coming at a time of what I find interesting when many ETF providers are launching emerging markets ETF X China they're excluding China from the emerging markets and we can put up on here EMXC and I know you've told me it is a mistake for global investors to exclude China

regardless of the politics very briefly explain why we should it is a mistake to exclude China yeah so our shop also has a EMX out China now to do X China I would say that's not about eliminating China out of your portfolio you know to do a EMX China is because China is so large that you don't want your EM to just be China right if you just keep China in there China sometimes is 30 sometimes 50% depending on how it's performing. So ex-out China gives you flexibility to over your underway China,

just like you take US out of the global portfolio, otherwise US has dominated global portfolio and you wouldn't be able to see Japan or UK. The reason why it's a mistake to take out China is similar to what Dave has mentioned. China is so big as the economy, right? Contributes, I think, to 20% of global GDP grow. It is almost the size of the US

in terms of the sheer size of the GDP. GDP. It's not a different phase in its growth trajectory. And it's per capita GDP is still growing quite rapidly. You want to participate in that, right? You want to participate in their growth, which is very uncorelated with the U.S. growth. And that's great for your portfolio. It's another way of buying different demographics, different production function, different risk premium. And then I think as a careful investor, if you're well diversified, it's a great way to build a better portfolio. Right. Participating in growth sounds good, Dave, but it's not not the same as participating in stock market gains. China has had growth, but not stock market

gains. That's what drives investors a little bit crazy. And Dave, this is a good moment, I think, to remind everyone that China investing is very confusing, because you're dealing with really almost three different kinds of investments here. You've got mainland China, you got Hong Kong, and you have China stocks to trade outside of China, like Alabama, the trades in the U.S. and now also in Hong Kong. And there's different ETFs for all of them. And folks, we've gone over this many times. It's one of the reasons ETF Edge exists. You could sometimes get very different outcomes depending on what parts of China's investing landscape that you are looking at. So, for example, the I-Chair's large cap at the FXI, which is the oldest one, it's 20 years old. Those are all

Hong Kong stocks. There's the MCHI, which is the broadest one that's out there. That's Hong Kong, China mainland and US stocks, K-Web, which is China Internet stocks, includes U.S. listed shares. Dave, I guess the point here, I'm putting up a screen here, I don't know if you can see it, is you can get a lot of different outcomes depending on which China ETF that you're investing. And now the one you've chosen here that you're using is essentially nine large stocks. But can you address that sort of difficulty of trying to figure out what kind of ETFs or what kind of China you want to invest in? Yeah, no, you're absolutely right.

And so we've seen the expansion of EMX China. We've now seen the expansion of a multitude of approaches to access in China and all with different nuances. And again, that was one of the pieces of us launch and drag was that even though there's already a lot of options out there, what was missing was the precision to just the largest leading companies. And so we're an investor for really any TF, but especially when you're picking a sector or industry in the US or in the case of China.

You really need to know what you own, do your homework, understand what the outcomes may be. Don't necessarily be a rearview rookie because really most of them have had challenging performance to the grand scheme of things, especially rather than the US. And going forward, again, if we believe in the stimulus, believe in an opportunity to access it undervalue China, many of them actually may be attracted solutions for you.

But in the case of our ETF drag, you know you're just going to have exposure to those 5% stock nine right now that are the market leaders. Many of them are actually listed in the U.S. or have very liquid ADR in the U. 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. Dave Mata, CEO of Roundhill Investments, continues with us now. Dave, thanks for sticking around. I wanted to follow up and ask you about. the Magnificent 7 ETF we've been talking about the China magnificent I guess

Magnificent 9 ETF that you just launched but the Magnificent 7 ETF MAGS launched what a year and a half ago perfect market timing there and I think you have $800 million in assets under management what it has interest in this waned at all given that it's become a little a little bit of a meme that's seeped into the the investing consciousness now is that meme still relevant yeah i'm not sure if i'm quite willing to call the magnificent seven a meme yet uh however uh i think it's a term that has and has stuck around i think a lot longer than folks may be anticipated and the reason being is that you know this group of stocks even though there may be some outperformance of the video or meta like we're seeing today and underperformance

of tesla has actually exhibited similar similar characteristics where there are the leaders in growth the leaders in revenue. And when we think about investor access to negative seven, we saw, of course, a huge amount of interest of inflows into the ETF when it first, when it first launched, when performance is really ripping higher. Heading into this most recent earnings season, we've still seen inflows into the MAG's ETF, but it certainly has slowed a bit. And I think there's a good reason for that, of course, valuation and this is a really in my opinion of make or great earning people for many of these mcgift seven companies because we know they've been spending and spending on AI particularly on

buying chip from their fellow Magnificent 7 member nevidia and at some point i think it's definitely going to want to see that payoff so i think heading into this again this running season a little bit more cautious than what it's been but still interest is there and i know you have a couple of other ones that have on. You know, we've debated back and forth about thematic tech ETFs. But I remember we covered the, when the Metaverse was big, you brought in the Metaverse ETF, METV, which I thought was a very clever title there. And we also brought in when generative AI came in, you introduced the generative AI ETF. The symbol was chat on that. You've been very clever at introducing things right at the peak interest level for them.

How are the, is there still a lot of investor interest in AI and the Metaverse? Yes, this is interesting. We've seen a real bifurcation of interest in AI versus the Metaverse. So we know that the Metaverse ETF and Metaverse stocks really ripped higher, particularly in sort of the tail end in that COVID period. Of course, famously Facebook changed her name to meta to be reflective of these trends. But this is a theme that plays out sort of over five. 10 years, maybe even longer. And then there's thematic equity or themes in general that sort of can play out in the

here and now. And investors have really focused on the here and now. There's been a ton of economic uncertainty. We have a course have an election that's contentious, unresolved issues in the Middle East and Ukraine. And so investors who are interested in need want to kind of know about that the opposite future. So the metaverse, we believe, is still there.

been pushed out a bit as investors have focused more on what's going on with generate AI. Yeah, it's funny Mark Zuckerberg has you know meta stock has revitalized this year but not on the metaverse it's a lot the new glasses that he's introducing I would not call the metaverse but it's doing you know it seems to be reviving interest in the company it's kind of funny because he was betting on AR and I guess he would still say he's betting on A. But in the meantime, you know, these glasses got to made a big splash a week or so ago. And even Mark Zuckerberg seems to, you know, be finding new ways to keep moving on around that.

I wanted to just ask you about the, you're a big ETF watcher about the flows this year because they're quite remarkable. We're continuing to see inflows into the usual plain vanilla ETF stuff, the S&P 500 and that stuff. But active ETFs are getting a lot of money as well. And I think we have a shot at $900 billion, maybe even a trillion dollar year. ETFs have $10 trillion in asset under management and mutual funds keep shrinking. So this juggernaut is amazing to me because even in years when the stock market is slower like 2022 or down like 2022, we still get inflows. It's really rather remarkable to watch this juggernaut. Yeah, I know.

And I've been fortunate to be a part of the ETF industry for some. time now. And I think one of the reasons why we see resiliency of EPS work in down market and then resiliency of ETF growth in the market is because of the investor's choice. And certainly choice comes with more complication. But I think years ago, at least when I started the ETS industry at State Street, ETF's meant passive. So meaning only indexed funds, whether it's a stock market, bond market, or maybe access to a commodity like gold, that's of course all changed in the last few years. So now we know active managers comfortable with the ETF. They're seeing a lot of interest and flows because of that. And now the ETF

market has expanded again. We know firms have innovated in disrupting the structured note market, buffer ETF. Now we're seeing that happen in the opposite income market, where ETS providers are packaging strategies that are only used by institution for all types of investments. So I only see the EETF market continuing to grow because now we're seeing access in all of this area of four of them. All right. Dave, I'm going to have to leave it there. I appreciate chatting as always. Dave Mata is the CEO of Roundhill Investments. That does it for ETF Edge, the podcast. Thank you for listening. Join us again next week. And remember, you can see all of our shows, ETFedge.c.com. How does InvestcoQQQ rethink possibility? By rethinking

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