ETF Trends caught up with VanEck product manager William Sokol to discuss how to build a better China portfolio.
Is there a better way to approach investing in China?
As China continues its long march towards full integration into the global economy, we believe it’s important to consider a portfolio that reflects the entire Chinese opportunity set, including onshore, HK-listed and U.S.-listed companies. However, broad-based indices that cover the entire Chinese market may include companies with poor growth, value or quality attributes and may not provide the returns that investors seeking exposure to the growth potential of the Chinese economy are looking for.
VanEck Vectors China Growth Leaders ETF (GLCN) tracks an index designed to provide exposure to companies with sound fundamentals and the potential for growth. The MarketGrader China All-Cap Growth Leaders Index selects fundamentally sound Chinese companies with attractive growth potential at a reasonable price (GARP), regardless of size or listing location.
MarketGrader’s scoring methodology and stock selection process may help investors participate more fully in the growth of the economy by owning stocks with growth potential, while sidestepping some of the troublesome companies that are held in the benchmark indices.
Can GLCN help investors avoid low-growth SOEs or fraudulent companies?
State-owned enterprises (SOEs) can be problematic for investors, especially in emerging markets countries like China. SOEs can be plagued with ineffective monitoring, poor transparency, ambiguous accountability, and lethargic growth characteristics. While SOEs are not excluded from the MarketGrader China All-Cap Growth Leaders Index investable universe, the fundamental process typically leads to a reduction in SOE exposure compared to the broad onshore Chinese indices. We believe that exposure to growing, profitable SOEs is warranted considering the size and reach of their impact on the local economy, and because there are high quality SOEs operating in higher growth, consumer oriented sectors of the economy that are often overlooked by broad benchmarks
Poor governance and a lack of transparency can also cause problems for investors. A common question we hear centers around the data quality that companies produce in emerging markets countries (especially China). Essentially, how can U.S. investors trust in Chinese companies to produce quality data, and how can bad actors be caught before global investors pay the price?
MarketGrader’s proprietary scoring methodology uses inputs across a wide range of time-diversified metrics across three main factors: growth, value and quality. Because the metrics are diversified across factors and time periods, the resulting single MarketGrader Score is robust, and may allow investors to sidestep potential bad actors.
Luckin Coffee is probably the most high-profile case of accounting fraud we’ve seen in the last few years coming from China. In April of 2020, under pressure from activist short-sellers, Luckin admitted to inflating company sales in 2019 by around $310 million dollars.
According to MarketGrader, Luckin Coffee has been considered a “Sell” since coverage was initiated in 2019 and has never been included in the index. The company was exhibiting poor growth, value and quality metrics for some time, even despite the fraudulent accounting activity. Even though bad actors effectively falsified certain accounting records by boosting revenues, Luckin’s poor financial condition was evident across other metrics, which led to a consistently negative MarketGrader Score.
What is the selection process for the underlying portfolio?
The index seeks to provide access to fundamentally sound Chinese companies with attractive GARP. The starting universe is the entire Chinese opportunity set, regardless of size or listing location. From there, eligible companies are ranked according to a composite score derived from a company’s growth, value and quality attributes, weighted in that order. The top 200 names based on this score are included in the portfolio, ranked according to free-float market cap with a 5% cap on individual positions. The ETF and index rebalances semi-annually.
How does the index compare to broad market benchmarks?
The index’s fundamental characteristics compare favorably to broad market indices, such as the CSI 300 Index or MSCI China Index. Comparative valuations are essentially in-line with the broad market, while growth metrics are higher. This indicates that the portfolio is offering GARP exposure, where investors are accessing stocks that have growth potential which are trading at reasonable valuations. Additionally, there are fewer companies with negative sales and EPS growth, indicating a higher quality of earnings for constituents.
PEG ratios are a popular way to determine if an index is GARP-aligned. PEG ratios are calculated by dividing a valuation metric (i.e., P/E) by a growth metric (i.e., sales or EPS growth rate). PEG ratios under 1 are generally considered favorable under a GARP lens. As seen below, the MarketGrader China All-Cap Growth Leaders Index has a PEG ratio under 1, while the broad benchmarks have PEG ratios above 1.
Selected Characteristics as of 6/30/2020
|MarketGrader China All-Cap Growth Leaders Index||CSI 300 Index||MSCI China Index|
|% w/ Negative Sales Growth||0.77%||9.68%||5.42%|
|% w/ Negative EPS Growth||5.54%||20.86%||13.76%|
Source: VanEck. See definitions below.
For the table above: Note high growth rates (Sales, EPS) compared to similar P/E as benchmarks. This indicates a better price for higher comparable growth rates.
Forward P/E represents the weighted harmonic mean of 12- month Forward Price to Earnings Ratio. P/B represents the weighted harmonic mean of the Price to Book. Weighted Sales Growth represents the weighted sales growth over the previous 12 months, with outliers over 5 standard deviations from the mean excluded. EPS Growth represents the weighted EPS growth over the previous 12 months, with outliers over 5 standard deviations from the mean excluded. PEG represents the weighted harmonic average of each constituent’s Trailing 12 month Price to Earnings Ratio divided by its sales growth over previous 12 months. Negative Sales Growth and Negative EPS Growth represents the weighting of the portfolio consisting of stocks with negative sales and EPS growth.
MarketGrader China All Cap Growth Leaders Index is comprised of Chinese equity securities which are generally considered by MarketGrader (the “Index Provider”) to exhibit favorable fundamental characteristics according to the Index Provider’s proprietary scoring methodology.
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).
The CSI 300 Index is a free-float weighted index that consists of 300 A-share stocks listed on the Shanghai or Shenzhen Stock Exchanges.
This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. Fund holdings will vary. For a complete list of holdings in the ETF, please click here https://www.vaneck.com/etf/equity/glcn/holdings/.
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.
VanEck Vectors China Growth Leaders ETF (GLCN) is not sponsored, endorsed, sold or promoted by MarketGrader.com Corp. (“MarketGrader”). MarketGrader’s only relationship to VanEck Associates Corporation (“Licensee”) is the licensing of the MarketGrader China All-Cap Growth Leaders Index (the “Index”) which is determined, composed and calculated by MarketGrader and Solactive AG, as Index Calculation Agent, without regard to Licensee. MarketGrader has no obligation to take the needs of (Licensee) or the owners of the Fund into consideration in determining, composing or calculating the MarketGrader China All-Cap Growth Leaders Index. MARKETGRADER SHALL NOT BE A PARTY TO THE TRANSACTION CONTEMPLATED HEREBY, AND IS NOT PROVIDING ANY ADVICE, RECOMMENDATION, REPRESENTATION OR WARRANTY REGARDING THE ADVISABILITY OF THIS TRANSACTION OR THE FUND OR THE ABILITY OF THE INDEX TO TRACK INVESTMENT PERFORMANCE. MARKETGRADER HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES, EXPRESS, STATUTORY OR IMPLIED, REGARDING THIS TRANSACTION AND ANY USE OF THE INDEX, INCLUDING BUT NOT LIMITED TO ALL IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE OR USE, AND NON-INFRINGEMENT AND ALL WARRANTIES ARISING FROM COURSE OF PERFORMANCE, COURSE OF DEALING AND USAGE OF TRADE OR THEIR EQUIVALENTS UNDER THE LAWS OF ANY JURISDICTION. UNDER NO CIRCUMSTANCES AND UNDER NO THEORY OF LAW, TORT, CONTRACT, STRICT LIABILITY OR OTHERWISE, SHALL MARKETGRADER OR ANY OF ITS AFFILIATES BE LIABLE TO ANY PERSON FOR ANY DAMAGES, REGARDLESS OF WHETHER THEY ARE DIRECT, INDIRECT, SPECIAL, INCIDENTAL, OR CONSEQUENTIAL DAMAGES OF ANY CHARACTER, INCLUDING DAMAGES FOR TRADING LOSSES OR LOST PROFITS, OR FOR ANY CLAIM OR DEMAND BY ANY THIRD PARTY, EVEN IF MARKETGRADER KNEW OR HAD REASON TO KNOW OF THE POSSIBILITY OF SUCH DAMAGES, CLAIM OR DEMAND.
MarketGrader China All-Cap Growth Leaders Index is not sponsored, promoted, sold or supported in any other manner by Solactive AG nor does Solactive AG offer any express or implicit guarantee or assurance either with regard to the results of using MarketGrader China All-Cap Growth Leaders Index and/or its trademark or the Index Price at any time or in any other respect. MarketGrader China All-Cap Growth Leaders Index is calculated and published by Solactive AG. Solactive AG uses its best efforts to ensure that MarketGrader China All-Cap Growth Leaders Index is calculated correctly. Irrespective of its obligations towards MarketGrader, Solactive AG has no obligation to point out errors in MarketGrader China All-Cap Growth Leaders Index to third parties including but not limited to investors and/or financial intermediaries of the financial instrument. Neither publication of MarketGrader China All-Cap Growth Leaders Index by Solactive AG nor the licensing of MarketGrader China All-Cap Growth Leaders Index or its trademark for the purpose of use in connection with the financial instrument constitutes a recommendation by Solactive AG to invest capital in said financial instrument nor does it in any way represent an assurance or opinion of Solactive AG with regard to any investment in this financial instrument. “MARKETGRADER” and “MarketGrader China All-Cap Growth Leaders Index ” are trademarks of MarketGrader.com Corp. and have been licensed for use for certain purposes by Van Eck Associates Corporation. based on the MarketGrader China All-Cap Growth Leaders Index , is not sponsored, endorsed, sold or promoted by MarketGrader, and MarketGrader makes no representation regarding the advisability of investing in such product(s). VanEck Vectors China Growth Leaders ETF (GLCN)
MarketGrader China All-Cap Growth Leaders Index is calculated and published by Solactive AG. MarketGrader China All-Cap Growth Leaders Index is not sponsored, promoted, sold or supported in any other manner by Solactive AG nor does Solactive AG offer any express or implicit guarantee or assurance either with regard to the results of using MarketGrader China All-Cap Growth Leaders Index and/or its trademark or the Index Price at any time or in any other respect.
Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors can not invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested.
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/etfs . Please read the prospectus and summary prospectus carefully before investing.