According to Bloomberg, China’s economic growth remained fairly stable during 3QCY16 after recording a GDP growth of 6.7% YoY (within Bloomberg’s consensus expectation), underpinned by growth seen in the services and consumption economy. At the same time, as the A-share market still lags behind and had underperformed HSI by 6.4% in 3QCY16, there is still potential upside for us to capitalise on. To position for either the “old economy” or “new economy” theme, there are currently two ETF alternatives that investors could look to participate in. CSOP’s FTSE China A50 ETF (2822 HK) is the most direct play to the traditional economy theme, with prospective catalyst arising from possible MSCI’s A-share inclusion. On the other hand, investors who are interested on the new economy theme play, which leverages on: (i) China’s new economy of IOT, and (ii) transition towards consumption and services as well as the introduction of Shenzhen-Hong Kong Stock Connect, could consider CSOP’s SZSE ChiNext ETF (3147 HK).

Taking a long-term view on China. While there is still lingering uncertainties over the health of China’s economy, which include problems such as high inventory, over-investment and Yuan depreciation, the stock market seems to have priced-in the negatives while its valuation had reached a historical low level. Referring to Figure 1 and Figure 5, the low base valuations of China A50 Index (9.4x Fwd. PER, with 3-year historical Fwd. PER range of 6.6x-12.2x) and ChiNext Index (36.7x Fwd. PER; with 3-year historical Fwd. PER range is 30.0x-83.2x) of China’s stock market indicates that downside could be limited in the shortterm barring any Black Swan event, which provides a good opportunity to enter the market for investors with a longer-term horizon. From here, we will take a look at the two possible alternatives to participate in China equities market through ETFs by starting with the traditional economy on China A50 Index via CSOP’s FTSE China A50 ETF (2822 HK) before elaborating more on the new economy theme play on ChiNext Index via CSOP’s SZSE ChiNext ETF (3147 HK).

The “Old Economy” Theme - MSCI’s A-share inclusion on the cards. The MSCI Index rebalancing is likely to happen as early as May 2017, whereby it is expected to announce the inclusion of China A-shares. The China and Hong Kong markets are taking this announcement positively as the plan to include traditional blue-chip Chinese A-shares into an international benchmark affirms confidence on the Chinese’s capital market reforms, thus far. According to industry reports, assuming a 5% partial inclusion factor as proposed by MSCI, A-share companies would account for c.4.3% in the MSCI China Index and trigger a 1.1% weight increase for China in the MSCI Emerging Markets Index, triggering more fund inflows from institutional funds. According to Wall Street Journal, a full inclusion could see an estimated inflow as high as US1.5 trillion in assets for active and passive index tracking funds, according to Goldman Sachs.

China’s banking debt reform - The last piece of the puzzle for A-share inclusion. China’s State Council had on 10th October 2016 released the long awaited debt-for-equity swap guideline for banks and companies, to reduce the nation’s corporate bad debts. These policies are expected to rejuvenate the banking sector and China Construction Bank is leading the way with discussions on more than 50 debt-to-equity deals from their announcements. Since 2015, six Chinese lenders had raised capital via public listing, the largest IPO for 2016 being Postal Savings Bank, which raised USD7.4b recently. These market-driven initiatives will keep the banking sector on the right track in addressing their non-performing loans. With this in place, MSCI Emerging Market Index A-share inclusion chances would be greatly enhanced.

The “New economy” Theme - Riding on China’s growth transition. Following the recent four-month rally in what industry recognized as the old economy names, focuses are now shifting towards China’s new economy sectors, which include industries such as the technology, media, healthcare, high-end manufacturing and renewable energy. These sectors are likely to benefit from policy-driven developments as well as the rebalancing of China’s economy. To elaborate further, China’s economic growth drivers have very much transition towards consumption and services from investment and manufacturing. As an indicator of the structural change in the economy, service sector accounted for 52.8% of the nine-month 2016 GDP figures. Furthermore, the new China index (S&P New China Sectors Index) had outperformed the HSCEI index (which include mostly old economy China stocks) over the past six months (refer to appendix at the back of this report), reinforcing the case of change in China’s growth drivers.

SZ-HK Connect - Train to China’s transformation to “new economy” and A-share market. The SZ-HK Connect is another key catalyst that will boost the ChiNext Index – the home of China’s “new economy” counters. The stock trading link between Shenzhen (SZ) and Hong Kong (HK) has recently been approved and will provide a new avenue for global investors to access Chinese A-shares listed in Shenzhen (c.USD6.5t equity market) that were previously unavailable to foreign investors. Shenzhen’s “new economy” stocks with attractive themes such as Internet of Things (IOT), media, health care and consumer discretionaries will benefit greatly from the Connect. Besides, Tech stocks, in particular, are expected to garner investors’ interest whereby nearly a fifth of Shenzhen’s stock market are tech companies, as compared to Shanghai where tech stocks make up just c.4% of the market. For those who look to venture into this growth transition, it’s great to know that the only ETF in Hong Kong that tracks the Shenzhen ChiNext board is the CSOP’s SZSE ChiNext ETF (3147 HK).

Two CSOP ETF alternatives. To sum up again, the most direct play to MSCI A-share inclusion will be the CSOP’s FTSE China A50 ETF 2822 HK, while CSOP’s SZSE ChiNext ETF 3147 HK is exposed to small-to-mid cap companies involved in China’s new economy movement which will benefit from the SZ-HK Connect introduction. Retail investors who look to ride on the above themes could consider these aforementioned ETFs.

Source: Kenanga Research - 21 Oct 2016