Chinese stocks are in the midst of one of the sharpest rallies in five years, providing some support to VanEck Vectors China Growth Leaders ETF (GLCN), a new approach to an old China ETF issued by VanEck.

The new index for GLCN broadens the universe of Chinese companies eligible for inclusion from the fund’s current index. The new index that GLCN will seek to track includes locally listed China A-shares, as well as Chinese companies listed on eligible stock exchanges as determined by the index provider, allowing investors to access leading growth companies from the full China opportunity set.

An important trait offered by GLCN is that its index eschews state-owned enterprises (SOEs), which often lag other Chinese stocks.

“A large part of this underperformance can be explained by the dual ownership structure of state-owned enterprises (SOEs),” notes MarketGrade, GLCN’s index provider. “This led to both a massive overhang of state-owned shares as well as the sometimes contradictory objectives between state and private owners, which gave rise to a culture within many SOEs of stagnation, inefficiency, and bureaucracy, resulting in dismal stock returns. With a market capitalization of USD 4.7 trillion, SOEs account for 58% of the entire A-share market and comprise 69% of the CSI 300 Index, 50% of MSCI China Index’s, and 48% of the FTSE China 50 Index’s total market capitalization.”

GLCN Benefits

GLCN allocates about 31% of its total weight to the growth of its consumer discretionary, technology, and communication services sectors. Those are sectors that are light on SOE exposure, underscoring the fund’s utility.

“Investors interested in China’s stock market can avoid the pitfalls of overexposure to inefficient, slow-growth SOEs through a stock selection methodology that is more attuned to the true drivers of Chinese economic growth,” notes MarketGrader. “MarketGrader selects companies that are growing at a faster rate than the overall economy and that possess attributes associated with sound capital stewardship and robust fundamentals, but whose future value is not yet reflected in their share price.”

There are plenty of reasons, including some glaring ones, why investors looking for China exposure may want to favor the GLCN strategy.

“Perhaps the most telling amongst all the metrics, especially in the context of the oversized role SOEs play in China’s equity market, is that three-quarters of all SOEs in China have a return on equity below 10%. This confirms the thesis that these companies’ financial decisions have little to do with generating shareholder returns and much to do with acting as agents on behalf of the Chinese state in its various forms,” notes MarketGrader.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.