Build a Better China PortfolioCarlos Diez, MarketGraderJuly 20, 2020
This blog is adapted from the white paper, “The Chinese Equity Market Paradox,” published by MarketGrader.
The benefits of China’s ongoing economic growth will likely accrue to the country’s best companies. However, broad-based indices have high exposure to companies with poor growth, value or quality attributes. This is largely a result of the dominance of slower growth, and often inefficient, state-owned enterprises. We believe a stock selection methodology founded on growth, valuation and quality fundamentals can be used to identify and gain exposure to the companies most aligned with the economic growth of China.
Focus on Company Selection
While absolute valuation multiples such as price to earnings or price to book ratios are useful to help investors understand the price the market is willing to pay for a particular company’s stock, they lack context. This is especially true when comparing companies of different sizes and business models that operate in different industries and sectors.
This is where a growth at a reasonable price (GARP) framework is useful. GARP looks at a stock’s valuation in the context of the growth in its underlying business, through the lens of fundamentals such as sales, cash flow and net income. This approach is particularly useful in China given the disparity between the country’s rapid economic growth and the poor economic returns generated by a large portion of its publicly traded companies.
The MarketGrader China All-Cap Growth Leaders Index selects companies with consistent and sustainable growth with robust fundamentals that are trading at an attractive valuation relative to the company’s growth rate. This “GARP plus quality” approach can be put to the test by assessing it through the price to earnings growth (PEG) ratio.
Does GARP Work in China?
The PEG ratio is a measure of a stock’s price-to-earnings (P/E) divided by a growth measure. It provides investors with a measurement of not just the stock’s price relative to its earnings but rather to its earnings growth. It effectively measures how much investors are paying for a stock’s growth premium.
More than half of MarketGrader’s China Growth Leaders Index constituents are valued at less than one unit of P/E for every unit of earnings growth, which is considered to be an attractive valuation. By comparison, the percentage of companies in the CSI 300 Index, CSI SOE Composite Index and MSCI China Index with PEGs between zero and one are 38%, 30% and 37%, respectively.
Distribution of PEG Ratios by Index
Source: FactSet; Market Grader; China Securities Index Co.
How to Invest
The VanEck Vectors® China Growth Leaders ETF (GLCN) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the MarketGrader China All-Cap Growth Leaders Index (MGCNGRNR). The Index consists of 200 companies domiciled in China that the index provider has determined exhibit favorable fundamental characteristics.
This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.
MarketGrader China All-Cap Growth Leaders Index consists of 200 companies domiciled in China that the index provider has determined exhibit favorable fundamental characteristics.
The CSI 300 Index is a free-float market capitalization weighted index compiled and managed by China Securities Index Co. Ltd. consisting of 300 A-share stocks listed on the Shenzen and/or Shanghai Stock Exchanges.
The MSCI China Index captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 704 constituents, the index covers about 85% of this China equity universe.
The CSI SOE Composite Index tracks the performance of all listed state-owned companies in China.
An investment in the VanEck Vectors China Growth Leaders ETF may be subject to risks associated with investments in Chinese securities, including A-shares, which include risk of the RQFII regime and Stock Connect program, foreign and emerging markets investments. In addition, the Fund is subject to foreign currency risk, non-diversification risk, and other risks associated with investing in the consumer discretionary sector, consumer staples sector, financials sector, industrials sector, swaps, futures, investing in other funds, small-and medium capitalization companies, cash transactions, equity securities, market, operational, index tracking, authorized participant concentration, no guarantee of active trading, passive management, fund shares trading, premium/discount risk and liquidity of fund shares and concentration risks, all of which may adversely affect the Fund.
The Fund may gain exposure to the China A-Share market by directly investing in China A-Shares and investing in swaps that are linked to the performance of China A-Shares. An investment in the Fund involves a significant degree of risk, including, but not limited to, risk of the RQFII regime and the Fund’s principal investment strategy, investing in China and A-shares, investing through Stock Connect, foreign securities, emerging market issuers, foreign currency, consumer discretionary sector, consumer staples sector, financials sector, investing in swaps, futures, other funds, small-and medium-capitalization companies, cash transactions, equity securities, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversification, concentration risks and the Adviser’s and Sub-adviser’s ability to manage the Fund, which depends upon the availability of China A-Shares and the willingness of swap counterparties to engage in swaps linked to the performance of China A-shares all of which may adversely affect the Fund. The Fund may invest in derivatives, which entail certain risks, including counterparty, liquidity, and tax risks (including short-term capital gains and/or ordinary income). Foreign and emerging markets investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Fund’s returns. The Fund may also invest in shares of other funds and absorb duplicate levels of fees with respect to these investments. Small-and Medium-capitalization companies may be subject to elevated risks.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
Authored byCarlos Diez
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