Giving Canadians investment exposure to China

By Darren Matte

There’s no denying that China’s economy has become a major player in the global equity market. Yet it’s likely that very few Canadians have significant investment exposure to the country. According to Mark Noble, senior vice-president of ETF Strategy at Horizons ETFs, as the Chinese economy grows, the most efficient way for investors to take advantage is by gaining exposure to the Chinese companies that are directly fuelling that growth.

“If you look at the average Canadian portfolio, it is typically highly overweight in Canadian equities, which only represent 3% of the global market,” Noble says. “If you want exposure to the full growth of the global equity market, considering the growing consumer base that will come out of Asia for the next 50 years, it stands to reason that you should consider gaining exposure to that equity market.”

Noble adds that many investors and their advisors are not investing directly in emerging markets and only have exposure through commodities. As China transitions from industrial expansion into consumer goods and services, there is a greater need to tap into companies supplying the Chinese marketplace.

To address this issue, Horizons created the China High Dividend Yield Index ETF (HCN) in 2016. The ETF seeks to replicate the performance of the Hang Seng High Dividend Yield Index, which is designed to measure the performance of Hong Kong-listed equity securities characterized by high dividend yield. HCN invests in an underlying Hong Kong-domiciled and -listed ETF that seeks to provide investment results that closely correspond to the performance of the index.

While HCN tracks Hong Kong-listed equity securities, Noble notes that more than 50% of the companies listed are actually in mainland China. To be listed on the Hong Kong exchange, companies face higher standards, making HCN a lower-risk investment option than securities listed on mainland exchanges since it has exposure to blue-chip companies and a play towards long-term Chinese growth.

“During a downturn, the equity securities in which HCN invests tend to perform better than the Chinese 300 Index,” Noble says. “The reason we like the Hong Kong listing is because it has a well-established securities market that is on par with markets like those in Canada and the US. Companies need to go through a more in-depth due diligence process than on the mainland exchanges, so you are getting more blue-chip companies with positive cash flows and balance sheets. They don’t offer the same torque on the upside, but they offer a less volatile return and take advantage of a big movement in the Chinese equity market.”

While year-to-date, the Chinese market is up by double digits, Noble notes that HCN is up 7.1% as of February 28, so it is still capitalizing on this uptick.

“The other thing that is very attractive about Hong Kong-listed securities is that this ETF has exposure to the 50 largest dividend-paying stocks in China, and the dividends being paid are quite attractive,” Noble says. “It is about 6%, so roughly double what you get with developed market equities in Canada. It has been a strong source of dividend income for investors.”

For Noble, the advantages of the ETF come down to a pair of factors: lower volatility and exposure to the long-term Chinese growth story. “Most investors can get their head around the fact that China will ascend to bigger prominence on the global equity market. Currently, it is underweight compared to global equity exposure, so you will only see the global weighting increase.”

There’s also the fact that Chinese consumers tend to purchase Chinese-made goods. “When you look at some of the large companies like Google and Apple, they want to have penetration in China,” Noble says. “But instead of using Google in China, they use Baidu. Instead of Facebook, it’s WeChat. Instead of Amazon, it’s Alibaba, and so on. So you have large regional champion companies tapping into the other 30% of the world’s population. To capture that growth, investors need to gain exposure to Chinese regional equities.”

While there are still risks that come with investing in China, HCN tries to offset them while still providing exposure to the country.

“There are risks from growing pains in regulation, concerns such as zombie financial institutions and shadow banking that can scare away foreign investment dollars,” Noble says. “Hong Kong is a nice go-between because the companies meet strict standards.”

He adds that while investors need to be aware of the economic risks in China, there can be a greater return trade-off.

“There is a lot of leverage in debt still in the Chinese marketplace, and there will probably be more over the next couple years as they invoke more stimulus measures to get the economy going,” he says. “That continues to be a risk. In the short term, you could potentially see a significant economic slowdown – not that I am predicating it. There is volatility in some of these stocks because there are still unknowns, such as where they get their earnings, how large their markets are and questions around accounting. You could have some companies where regulatory oversight isn’t quite the same as in North America and fraudulent equity practices could exist. It is a volatile equity space, but there is potentially a big risk/return trade-off.”

While China experienced headwinds last year due to an economic slowdown and the impact of US tariffs on exports, Noble believes the market has priced in such factors. He feels that things are improving, based on signs that China and the Trump administration are making progress on a trade deal. “I think both economies recognize they are integrated, and there are serious issues they want to work out,” he says.

He adds that if a deal is reached, the stocks of certain Chinese companies could potentially take off. As the Chinese economy transitions more toward goods and services, sectors such as financials, consumer staples and technology should see growth. Even if GDP appears to drop during this transition, Noble says this isn’t reflective of the big picture, which could see China becoming the most important and potentially the most influential economy in the world – all the more reason Canadian investors should have some exposure to this market.

The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the Horizons China High Dividend Yield Index ETF (the “ETF”) or returns on investment in the ETF.

Horizons ETFs is a Member of Mirae Asset Global Investments. Commissions, management fees and expenses all may be associated with an investment in the Horizons China High Dividend Yield Index ETF (the “ETF”) managed by Horizons ETFs Management (Canada) Inc. (the “ETF”). The ETF is not guaranteed, its value changes frequently and past performance may not be repeated. The prospectus contains important detailed information about the ETF. Please read the prospectus before investing.

The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.