5 things to know about Chinese stocks

(NYTIMES) – Americans have good reasons to be wary of investing in China. It’s easy to get caught up in the headlines and go no further.

It’s easy to be turned off. Yet, with some caveats, I think the benefits of putting some of your money into Chinese stocks and bonds are more compelling than the reasons for staying away.

Chinese stocks may be part of your retirement nest egg

Many Americans already hold Chinese securities indirectly without realising it, because global stock and bond funds contain them. Until I checked, I wasn’t sure about my own retirement accounts, which mainly contain Vanguard index funds. Yes, a smattering of Chinese stocks and bonds are tucked away in them. Other large fund providers, like Fidelity, BlackRock, State Street and T. Rowe Price, include Chinese securities in global funds.

If you learn that you’re invested in Chinese securities as part of a broadly diversified portfolio, don’t panic, on purely financial grounds, anyway. And if you do not have any money in China yet, it may make sense to start, in small doses and through mutual funds and exchange-traded funds, despite the current troubles. With certain reservations, I think holding a piece of Chinese financial markets is a good thing.

The fundamental reason is simple: Chinese markets are important, and they are becoming even more so.

A portfolio in 2021 isn’t global without China

The teachings of finance since at least the middle of the 20th century have recommended that investors hold thoroughly diversified portfolios of stocks and bonds, reflecting the entire financial universe, in an appropriate asset allocation. And in the 21st century, China is a vital part of global financial markets.

To exclude Chinese securities from global portfolios at this stage strikes me as roughly equivalent to insisting that the Earth is flat.

As Mr Jason Hsu, founder of Rayliant Global Advisers in China and an adjunct professor of finance at UCLA, said: “In China, the invisible hand of capitalism wears a red glove, and regulations can be very heavy-handed. Yet it’s still an important place to invest.”

Partly because of such issues, major global index firms are not yet allowing China to punch its full weight based on the value of its US$10 trillion (S$13.5 trillion) stock market and US$16 trillion bond market.

Chinese stocks account for a bit more than 4 per cent of global stock indexes and Chinese bonds make up more than 7 per cent of some global bond indexes.

Reasons for concern

Undeniably, there are excellent reasons for Americans not to put money into China. First, the political differences, short and long term, can scarcely be overstated.

US officials say China is now America’s most threatening adversary and engages in pervasive human rights violations. Chinese leaders proclaim the superiority of their own approach.

Mr Xi Jinping, the head of the Communist Party and China’s paramount leader, warned early last month that any foreign powers trying to stop China’s ascendance would “crack their heads and spill blood on the Great Wall of steel built from the flesh and blood of 1.4 billion Chinese people.”

But it is also worth noting that since the reopening of China in the 1970s and 1980s, there has been “a remarkable improvement in the quality of day-to-day life for hundreds of millions of people”, Mr Andy Rothman, an investment strategist for Matthews Asia, said.

Regulatory issues are troubling

Even if you are inclined to invest some money in China, you will quickly find that a host of nettlesome regulatory issues plague Chinese public companies, particularly the roughly US$2 trillion worth listed on American exchanges as ADRs, short for American depositary receipts.

The US has designated dozens of these companies as being so connected to Chinese military and intelligence services that they are potential threats to national security. Some have been barred from trading in the United States and delisted from major global stock indexes.

A three-year clock ticks for the rest of the Chinese companies traded in the US. Under a US law passed last year, they must submit financial audits to US regulators, yet China does not permit such information to leave the country.

That may be impossible for these companies to resolve. “We don’t expect they will comply,” said Ms Elizabeth Kwik, an investment manager for Aberdeen Standard Investments in Hong Kong. The odds are, she said, that “they will be ‘coming home’ to China”, where they can be traded without problems.

Chinese regulators have their own unsettling concerns about big tech companies. In November, they blocked the initial public offering (IPO) of Ant Group, the finance giant. Ant is a sister company of Alibaba, the e-commerce colossus, whose founders include billionaires Jack Ma and Joseph Tsai.

For many basketball fans, Mr Tsai is best known as the owner of the Brooklyn Nets and boss of Kevin Durant, Kyrie Irving and James Harden.

If you want Chinese shares, you can bypass New York

On the face of it, shares of Chinese Internet giants traded in American markets through ADRs might seem to be safer for Americans than shares sold in local markets like Shanghai, Shenzhen or even Hong Kong.

Yet in some respects, regulatory requirements for IPOs in China can be more stringent than those imposed by American regulators, Mr Hsu of Rayliant Global Advisers said.

One reason is that inexperienced investors in China who engage in “social gambling” move the local stock market even more than “meme traders” do in the US, he said. To calm the market, Chinese regulators require companies to have solid cash flow and earnings for listing on the domestic market, known as the A shares market. That is not needed for an IPO in the more laissez-faire US.

I would be careful about buying individual stocks. But I do like the idea of participating in the growth of China’s consumer market through fund portfolios, though I tilt towards index funds. Maintaining an indirect business connection with China, despite the ebb and flow of politics, seems to me humane and, potentially, lucrative.

But I’ve come to accept that I’m a die-hard globalist. If you can’t abide by this kind of thinking, I wouldn’t lose sleep over it. Stay local in your investing, then.

Yet be aware that Chinese spending is already so consequential that you will get some exposure to it anyway, through companies like Boeing, Caterpillar, General Motors, Ford Motor and Nike.

China is so important, it’s impossible to ignore.