How You Can Buy Chinese Stocks

Takeaways

• Why are Chinese stocks attractive

• Find out about the many and increased risks involved

• The options you have to buy them

Why are they attractive?

China's economic size is now respected the world over. As a huge country with a developing middle class who are ambitious to get on, it is creating wealth daily. This has led to Chinese companies increasing profits rapidly. In turn this has created a buoyant stock market where momentum investing is prevalent. No longer considered a frontier market, the Chinese stock market is widely followed at a local level.

It is impossible to ignore Chinese economic growth.

Although the mantra that this time is different is one to be cautious of, the inclusion of China a year ago in the MSCI Emerging Markets index, reflects it's importance. Western investors are also taking an increased interest in Chinese stocks. It also helps that Chinese regulators are curbing the shadow banking risk.

Helped by the rise of Alibaba and Tencent but also the expensive valuations of US stocks, China is starting to become more mainstream. Chinese stocks also give added diversification benefits as we saw in 2008, where the Chinese economy grew whilst the West's entered a recession.

You are exposed to political risk

It is impossible to speak about investing in China without speaking about risks. The US - China trade war launched by President Trump may abate with President elect Biden's presidency, but suspicion is sure to linger. Indeed with Trump banning certain Chinese stocks, this will  likely lead to further confrontation.

You will also have to contend with internal Chinese political risk. The pulling of the Ant IPO is a case in point. It would of been the biggest IPO of all time but was suddenly stopped at the 11th hour. It is thought this happened as a reprimand to Jack Ma, who has dared criticise the Chinese state apparatus.

Chinese shares can be difficult to access

One of the first difficulties you will have is actually buying Chinese stocks. The rules for A-shares mean your easiest route is to buy dual (US or Hong Kong) listed B-shares. Yet these are the larger Chinese listed companies, as a result you do not benefit from localised Chinese economic growth.

Individual shares are also higher risk due to their volatility, and they may not therefore be advisable for the average investor. You may also find that many brokers do not allow you to buy them through their platforms.

When Trump recently banned some Chinese stocks with US listings, Robinhood required holders to sell them. Buying Chinese listed stocks will also incur foreign exchange fees which can be as high as 1.5% per transaction.

Why a diversified portfolio is a better idea

Buying a fund, I.e. a portfolio of Chinese stocks, is ideal because of the diversification this will give you. You can go down either the passive or active route. Exchange Traded Funds (ETFs) are ideal passive investments. Both US and UK investors have choice from providers such as iShares.

Intriguingly iShares offers an ETF which tracks localised companies, i.e. draw their profits in the most part from China. This gives your stock portfolio a specific exposure to the Chinese economy. As many global growth funds have large holdings of Alibaba and Tencent (no bad thing), it is useful to invest in a China fund which does not - stopping duplication.

UK investors also have opportunities to invest in China focused investment trusts. Both Baillie Gifford and Fidelity have offerings in this area which compliment each other well. Active managers will deviate from the index. This gives them an advantage as they have the freedom to focus on a particular trend.

Fraud is a problem with Chinese stocks

Recent and high profile examples of fraud such as with Luckin Coffee means investing in Chinese companies is higher risk. You should be aware of other accusations which have been raised by high profile sceptics such as Carson Block. Your fundamental analysis should therefore be particularly forensic!

As a result it is best to let better resourced firms invest for you. Although professional firms can miss frauds too, they will often have an information advantage over individual retail investors. A margin of safety is also advisable: limit your exposure to an absolute maximum of 30% of your portfolio.

Conclusion

The USA -China trade war has pushed many Chinese listed stocks to de-list from US markets and move back to Hong Kong or Shanghai. As a result more than ever to gain exposure you will have to buy Chinese listed stocks.

They represent a geographical allocation that investors can no longer ignore but with higher potential downside risk. The concerns around creative accounting are real, but can be mitigated by trusting a professional investment manager or using an ETF.

Keeping an eye on the portfolio manager or ETF provider's strategy is important. Through their factsheets you will be able to see what they are buying and whether it is sensible. Remember it is your money, so if it does not feel right or the risk is too great, walk away.

The writer of this article has holdings in the China focused investment trusts and iShares ETF mentioned in this article.