Investors Are Missing This Serious China Investment Thesis
Here it is, people: China tech and domestic consumer-focused stocks are better than the top passive investment funds around the world
That includes funds tracking the S&P 500, FTSE Europe, India, Brazil, unsanctioned small cap Russia, MSCI China, FTSE China, the China A-shares and all of the MSCI Emerging Markets. Kiss that hard landing goodbye. Investors adhering to this line of thought are akin to flat-earthers at this point.
There are serious global competitors at work in China. Alibaba is Asia's Amazon. Guess what part of the world is growing more than Europe and the U.S. combined? Alibaba's corporate revenues are up around 60% year over year. Earnings per share beat market estimates by 21%. Smaller rival, JD.com, reported third-quarter earnings this month and revenues rose 39% on the year to $83.7 billion. Earnings per share beat consensus two-fold. Fourth quarter revenue guidance is up $3 billion to $110 billion, around 35% more than the same period last year.
"If you're a global money manager and were not in Asia this year because of China fears, face it, you got killed," says Tim Seymour, CIO of Triogem Asset Management in New York and best known as a host on CNBC.
Investors know the China consumer story. The tech story, on the other hand, is only partially known. Take last weekend's Global Shopping Festival for instance. Alibaba brought in $25.3 billion in one single day. That's half of U.S. Thanksgiving weekend sales from 2016, based on National Retail Federation data. Most U.S. fund managers think companies like Alibaba are overpriced. The investment advisors following their advice have paid a hefty opportunity cost with that line of thinking this year.
Mike Reynal is an emerging markets veteran. He runs the Victory Sophus Emerging Markets Fund (GBEMX), a multi-cap equity fund. For those who follow China tech close, Reynal has an "In Ma We Trust" view of the sector. His two largest holdings are Tencent and Alibaba, founded by billionaires Pony Ma and Jack Ma. They're not relatives. But they have one thing in common: over the last 12 months they're up 93% and 99% respectively, besting the beloved FANG stocks CNBC can't stop talking about: Facebook, Amazon, Netflix, and Google. And Apple, too. They've got them beat over the last year. Over the last 10 years, only Netflix has outperformed Tencent, the internet giant behind smart messaging programs like WeChat and online retail stores and gaming apps. Netflix is up over 5,000%. Tencent is up 3,500%. No one comes close in China tech.
"We have owned both for several years, and have added to both this year," says Reynal about Tencent and Alibaba. "We like the growth outlook, management teams, innovation and the dynamism of both companies. China has adopted very advanced social networking tools. Chat and communication rival American technology. On the shopping front, the Chinese firms have developed very advanced payment and shopping modules. Growth is remarkably robust. Both companies are using their strength in China to invest abroad and will begin competing on the global stage."
Reynal's fund is up 37.3% this year, slightly beating the MSCI Emerging Markets Index. Sophus Emerging Markets is not a pure play China fund. For investors who want to double down on China, this year has shown that there is really just one bet to place.
Only Game In Town?
There are undoubtedly hundreds of China exchange-traded funds and mutual funds. But one China specialist stands out this year in the ETF space. KraneShares' four-year-old CSI China Internet Fund (KWEB). It's top stocks include the usual suspects and some companies few here would know: TAL Education Group is a stand-out. The company's core business is in preparing young Chinese students at-distance learning opportunities for STEM classes in order to prepare them for college entrance exams, among other things. The stock is up 153% this year and 1,833% over the last five years. It also has a 1.66% dividend yield.
The ETFs brainchild is John Krane. He lived in Shanghai for a few years, and moved back stateside in 2010. KraneShares was born then. Their idea was to tap the dual trends of a growing high tech and consumer culture, along with the fact that the capital markets were opening for foreign investors. Last year, for instance, MSCI opted to include the mainland China shares listed in Shanghai and Shenzen in the massive MSCI Emerging Markets Index. China's market is modernizing. It is becoming more transparent. Companies are a bit easier to understand, but this is especially true for those listed on the NYSE and in Hong Kong.
KWEB's shares are only listed on those two exchanges.
Investors seemed to discover the fund this year. It started out with $250 million or so under management and now has $1.2 billion, the company said.
Brendan Ahern, a former director at iShares when it was with Barclays and later BlackRock, said this year has been a little easier to convince investors on buying China equities. The performance of the tech sector has a lot to do with it. "When the majority of headlines you read on China tell you that owning it is a liability, it makes for a very hard sell," he says. "But everyone can see how Chinese brands are becoming big players in emerging markets. The reason China has underperformed, along with emerging markets, is because the U.S. has been in a runaway bull market since 2009 so all of the institutional money centered there," he says. "Right now, highly visible companies like Alibaba have made it easier for us all."
In the U.S., there is an ongoing debate about how Amazon, the Alibaba of the West, is destroying shopping malls. Alibaba and other online retailers have leapfrogged that problem because malls are not ubiquitous in China like they are here. Alibaba said on Monday that 90% of its gross merchandise value was settled through Alipay, which is basically an app on a smartphone. Last year, it was 82%. Alibaba is less of a retail disruptor and more of a pioneer, giving people a chance to get goods they'd never get a hold of otherwise.
"China has a consumer class that is willing and able to spend on a grand scale," says Edmund Harris. He runs the Guinness Atkinson China Hong Kong (ICHKX) mutual fund. "China Mobile provides the communications backbone. Tencent provides the platform and Alibaba the online venue. Retailers are lining up to get on board."
Like KWEB, Harris' fund is up 46% this year in cumulative terms and is beating two of the biggest China ETFs, namely the iShares FTSE China and the Deustche X-Trackers China A-Shares fund. Harris doesn't have KWEB beat. Since it launched on Aug. 1, 2013, the digital economy centric ETF is up 124% cumulatively, beating the MSCI China Index.
Ahern and Reynal believe investors will start chasing China.
"I just got back from Hong Kong and everyone is upbeat about the market right now," says Ahern. "The takeaway I get is that we are going to see investors chasing performance as we head into 2018."
Most of the big money institutional investors are "at best neutral, and mostly underweight," Reynal says. "We see catch up...people (will) realize that growth is sustainable," he says.
The long-awaited hard landing hasn't materialized. It's become more of a politicized call on China than a market one. Non performing loans are in decline. The housing bubble never popped. The real estate market remains a key investment destination for them. Until China allows for the locals to buy foreign securities, they will undoubtedly keep buying domestic real estate.
The tech space in China is expensive, but so is Amazon. So are all the FANGs. But on forward-looking earnings basis, the main Chinese tech companies are not that out of line with our domestic tech megacaps. Bullish investors say China tech companies have higher 2017 and 2018 expected growth. Retail investors in China and Hong Kong have also been piling into these stocks, driving up the price to earnings ratios and making them generally unattractive to value investors. Wealth managers are left with a simple choice: keep with the underweight like most of their mutual fund partners worried about value and a hard landing that never comes, or go all in on an investment story that is beating the market this year and -- if Ahern, Reynal and Harris are correct -- has the legs for the long haul.