ETF strategies for China and India

Jan 3rd, 2013 | By | Category: Equities

China and India are the world’s most populous nations and its principal agents of economic growth. Over the decade ended in 2010, China’s GDP grew at an average annual rate of 10.3% while India’s grew at 7.4%, far surpassing anything offered in the developed world. For 2013, China and India are expected to grow by 8.2% and 6.0% respectively, versus 1.5% for developed economies. Though their outlooks vary, both countries represent compelling investment opportunities.

ETF strategies for China and India

India and China are the world’s most populous nations and key engines of global growth. Both make compelling investments.

A hands-off approach to investing in these emerging-market giants would be to split the desired aggregate allocation between the two countries using country-specific India and China ETFs, such as the db X-trackers MSCI India ETF (XCX5) and the HSBC MSCI China ETF (HMCH). Portfolio allocations could be could be weighted by market cap or GDP, or be blended together in a 50/50 split.

Alternatively, investors could buy an Asian emerging markets ETF, such as the SPDR MSCI EM Asia UCITS ETF (EMAS), which has approximately 41.1% allocated to China and India, or a BRIC (Brazil, Russia, India and China) ETF, such as the iShares FTSE BRIC 50 ETF (BRIC), which typically allocate around 54.0% to the two countries. Of course, these funds include other countries, thus diluting the exposure to India and China.

A more active approach would be to view the two countries from strategic and tactical angles, once again using country-specific ETFs, but this time varying allocations based on projections for short- and long-term performance.

So how do the two countries currently stack up? In 2012, India’s S&P CNX Nifty Index, a widely followed blue-chip index, ranked as the clear winner on market performance, rallying 26.2% in local-currency terms, compared to 22.8% for the MSCI China Index. The primary catalyst for India’s superior performance was the government’s third-quarter announcement of reform initiatives, including the resurrection of foreign direct investment (FDI) in multi-brand retail operations. According to Edward Bland, Director and Head of Research at Duncan Lawrie Private Bank: “The Indian government, at long last, appears to be taking steps to cut some of the red tape and investors can take heart that further long-pending reforms to stimulate the economy now stand a better chance of being implemented.”

The pensions and insurance industries are also set for FDI approval, but investors should be cautious, at least in the near term. India faces general elections in 2014, meaning electioneering may incentivise infighting and stall developments. Leading up to the elections, politicians are likely to espouse more populist policies, which could slow FDI liberalisation and impede efforts to trim India’s fiscal deficit.

Longer term, the big story in India continues to be its demographics. It will overtake China as the largest population in the world by 2030 and has one of the youngest populations among emerging-market nations, with nearly half its citizens under the age of 25. Add to this India’s so-called “soft” attributes, such as a democratic government and a free press that is rooting out corruption and the case for India over the long term looks compelling.

So what about China? Like India, there are challenges and opportunities. Louisa Lo, Head of Greater China Equities at Schroders, reckons that structural problems will persist in the Chinese economy in the near term but that the longer-term forces of urbanisation and economic rebalancing will continue to drive growth at sustainable levels: “While much of the market sentiment is negative, we retain our commitment to China’s long-term growth outlook. Continuing urbanisation of the rural population, increased domestic consumer spending and large scale infrastructure investment will drive China’s growth.”

Lo is also positive on valuations: “Chinese stockmarkets at current valuations appear attractive on price-to-book terms when compared to its historical range and across other regional markets. Bottom-up stock analyses have also shown that there is value emerging.”

Duncan Lawrie’s Bland also sees value in China: “We believe valuations in China have reached historically low levels and do not properly discount the pick-up in GDP growth rate and corporate earnings expectations. The transition to new leadership has gone smoothly, providing more certainty and promises more impetus to measures to support domestic consumption such as basic health care, and the acceleration of urban and infrastructure investment.”

Whilst not losing faith in India’s enormous growth and long-term potential, Bland believes that in the short term the market may once again be disappointed by the lack of progress, in contrast to China which is much better placed to implement large-scale reforms, such as the Special Economic Zones from the East Coast to the West, which will increase urbanisation, improve per capita income and drive consumer spending higher.

Clearly, China and India continue to offer huge potential and deserve a place in most passive long-term growth portfolios. For active investors desiring a hands-on approach, an overweight position in China in the short term, giving way in the longer term to an overweight position in India, could be how the smart money flows. ETFs offer a great way to effect these allocations cheaply and efficiently, and remove the need for stock selection, which can be difficult in opaque emerging markets.

Investors are spoilt for choice when it comes to China and India, with all the main ETF providers offering products. The following are all listed on the London Stock Exchange (LSE), though many have cross-listings on other European exchanges such as NYSE Euronext, Deutsche Börse (Xetra), Borsa Italiana and SIX Swiss.

The MSCI China Index is a free float-adjusted market capitalisation index reflecting the performance of the Chinese equity market by targeting all companies with a market capitalisation within the top 85% of the investable universe.

Amundi ETF MSCI China (CC1) TER 0.55%

HSBC MSCI China ETF (HMCH) TER 0.60%

db X-trackers MSCI China Index ETF (XCX6) TER 0.65%

MSCI China Source ETF (MXCS) TER 0.95%

The FTSE China 25 Index offers exposure to 25 of the largest and most liquid Chinese stocks listed on the Hong Kong Stock Exchange. The index is free float market capitalisation weighted with constituents capped at 10% of the total Index.

db X-trackers FTSE China 25 ETF (XX25) TER 0.60%

iShares FTSE China 25 ETF (FXC) TER 0.74%

The CSI 300 Index is a free float market capitalisation-weighted index consisting of the 300 largest Chinese A-share companies traded on the Shanghai and the Shenzhen stock exchanges. The index is quoted in renminbi (CNY).

db X-trackers CSI 300 ETF (XCHA) TER 0.50%

CS ETF (IE) on CSI 300 (CCS1) TER 0.50%

The MSCI India Index is a free float-adjusted market capitalisation index reflecting the performance of the Indian equity market by targeting all companies with a market capitalisation within the top 85% of the investable universe.

db X-trackers MSCI India Index ETF (XCX5) TER 0.75%

CS ETF (IE) on MSCI India (CIN1) TER 0.75%

Amundi ETF MSCI India (CI2) TER 0.80%

Lyxor ETF MSCI India (INRL) TER 0.85%

MSCI India Source ETF (MXIS) TER 1.15%

The S&P CNX Nifty measures the performance of 50 of the largest and most liquid Indian securities listed on the National Stock Exchange of India (NSE). The index is weighted by free-float-adjusted market capitalisation.

db X-trackers S&P CNX Nifty ETF (XNIF) TER 0.85%

iShares S&P CNX Nifty India Swap ETF (NFTY) TER 0.85%

There are numerous ETFs tracking India and China listed in the US, but one fund deserves special mention: the First Trust ISE ChIndia Index ETF (FNI). This NYSE Arca-listed fund is based on the innovative ISE ChIndia Index and provides exposure to both China and India, exclusively, in one fund. The ISE ChIndia selects the top 25 ADRs from China and India based on liquidity and then weights them according to an unconventional methodology whereby the top three ranked stocks in each country are weighted at 7% each; the next three in each country are weighted at 4% each; the next three weighted at 2% each, with the remaining weighted equally.

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