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Supplements » ETFs Report 2015

RENMINBI: Beware the banks

YuansAfter the turmoil in China’s markets this summer, Nick Fitzpatrick finds reasons to be optimistic, including good news for A-share ETFs – although their large holdings in the bank sector could hold them back.

China’s latest rate cut in October shows that the government is facing up to economic pressures – which is “positive news for equities”, says an active fund manager.

Xiaoyu Liu, fund manager for Asia-Pacific equities at Aviva Investors, says the government understands that investment-led growth cannot continue forever and that the People’s Bank of China (PBoC) wants to use its policy tools to smooth out the transition period.

In October, the PBoC cut its one-year benchmark interest rate to 4.35% and reduced the ratio of renminbi the banks have to hold. It was the sixth time since November 2014 that China’s central bank cut its rates. 

“This is positive news for Chinese equities, particularly companies in the property and utility sectors where there is high financial leverage,” the fund manager says.

The aim of the rate cut was to shore up the world’s second-largest economy. In the third quarter (Q3), growth dipped below 7% for the first time since Q2 2009, hitting 6.9%. China is aiming for 7% growth this year.

The weak economy has affected the profitability and cash flow of many companies, especially in the traditional sectors of industrial, manufacturing and real estate, Liu writes in a recent commentary. But he says the outlook is neutral to negative for China’s banks. Although the rate cut will help with non-performing loans, it will narrow their interest rate margin.

China A-share ETFs tend to be heavily weighted towards financials. For instance, the portfolio of ETFS-E Fund MSCI China A Go ETF, listed in London, was 31% financials at September 30, according to ETF Securities, which manages the ETF with E Fund Management (Hong Kong).

This was the ETF’s largest holding. Utilities, an area Liu expects to benefit from policy action in China, was the third-smallest at 4%.

The iShares MSCI China Ucits ETF is similar, with 32% financials and 5% utilities. Both ETFs track the MSCI China index.

The CSOP Source FTSE China A50 Ucits ETF, which tracks the FTSE China A50 index had a 41% weighting towards banks, which formed the ETF’s highest weighting as at September 30.

China was behind much of the equity turmoil in global financial markets in August and September.

John Greenwood, Invesco’s chief economist, says China is making the transition from a rapid-growth, largely state-owned economy focused on exports and massive capital investment programmes, to a slower-growth, slightly more liberalised and consumption-driven economy. 

The transition has been made more challenging by two sets of vulnerabilities. The first, he says, arises from the rapid build-up of debt since the Lehman crisis; the second springs from the divergence of regional and industrial performance between the provinces of the largely state-owned enterprises of the north-eastern ‘rust belt’ and the more service-oriented, private sector-dominated economy of the central and southern coastal zones.

In general, China still appears to represent a good long-term investment story.

David Riley, head of credit strategy at BlueBay Asset Management, says recent data suggests that China’s economy has stabilised on the back of a pick-up in consumer spending and services, offsetting the slowing rate of investment and industrial growth. He adds: “The latest economic data is consistent with our current assessment that a China hard landing and financial crash is a tail risk rather than a base-case scenario.”

©2015 funds europe