CHIX - CHIX: Valuations Nearing Trough Levels For Chinese Financials

2023-05-17 00:56:52 ET

Summary

• With most of the bad news now out of the way, the Global X China Financials ETF appears poised to extend its YTD outperformance.
• The large banks within the CHIX portfolio trade at particularly steep discounts, while the higher-beta plays offer leverage to the Chinese consumer-led recovery.
• In the meantime, investors get paid a well-covered mid-single-digit % distribution yield to wait.

Chinese bank valuations have suffered significant pullbacks in recent years, with current stock prices implying massive valuation discounts across all fundamental metrics. Large state-owned (SOE) banks, in particular, trade at the widest book value discounts via their H-shares despite consistently generating low teen % ROEs through the cycles. With their US and European banking peers also coming under pressure amid growing balance sheet and asset quality risks, major Chinese banks could finally catch a 'safe haven' bid due to their defensiveness in the face of a prolonged monetary tightening cycle globally. With China's macro conditions on the uptrend as well, the outsized dividend yields on offer screen quite favorably (well above the low to mid-single-digits % offered by bond proxies in the telco space), providing a reference point for an SOE-led re-rating from here. Elsewhere, a continued recovery in consumer confidence should also drive upside to the higher beta parts of the Global X MSCI China Financials ETF ( CHIX ) portfolio, including the regional banks, brokers, and major insurers. With most of the net interest margin ((NIM)) compression likely cleared post-Q1 results, and with the rate cut cycle at an end, all signs point to a re-rating from CHIX's current ~0.6x fwd P/B over the coming months.

Fund Overview – A Low-Cost Portfolio of China's Financial Industry Leaders

The Global X MSCI China Financials ETF tracks, before fees and expenses, the total return performance (including price and yield) of the MSCI China Financials 10/50 Index, comprising large- and mid-cap equities within the Chinese financials sector (per the Global Industry Classification System (GICS)). The ETF has seen its net assets remain unchanged at $26m despite the YTD performance, though its expense ratio has ticked up slightly to 0.66% (mainly management fees).

Per the latest factsheet , the ETF's largest exposure continues to be to the Major Banks at 33.6% (up from ~32% prior), though its second-largest allocation, Regional Banks, has seen its contribution fall to 19.5% (from ~21% prior). Multi-Line Insurance has also seen its portfolio allocation cut to 13.8% (down from ~15% prior), with Investment Banks/Brokers emerging as the third-largest sub-sector at 14.5% (up from ~14% prior). In total, the five largest sub-sectors had an 87.6% allocation, with four categories over the 10% threshold and five over 5%.

The fund's single-stock allocation has undergone some notable changes, with Ping An Insurance ( OTCPK:PNGAY ), formerly CHIX's largest holding, down to fourth on the list. In line with prior reporting, however, every other holding in the ETF's top five list (except Ping An) is a major Chinese bank. Commercial banking leader China Construction Bank ( OTCPK:CICHY ) is now the largest holding at 9.2% (up from 8.2% prior), followed by its SOE counterparts Bank Of China ( OTCPK:BACHF ) and Industrial and Commercial Bank of China ( OTCPK:IDCBF ) at 9.1% and 8.7%, respectively. China Merchants Bank ( OTCPK:CIHKY ) remains the fifth largest holding at 5.6% despite seeing its portfolio contribution decline by >1%pt. The portfolio is slightly bigger at 93 holdings (vs. 92 prior), but with the top ten holdings still accounting for an outsized share of the overall portfolio and the top four banking names (three of the Chinese' big four') contributing ~33%, this is a fund with concentrated exposure to China's banking sector.

Fund Performance – YTD Outperformer with an Attractive Distribution Profile

The ETF has risen further YTD, now reaching +9.7%, following a strong rally through April and May. That said, the long-term return profile remains below par – since its inception in 2009, CHIX has only appreciated in value by +1.2% annualized (NAV and market price terms), while over five and ten years, the annualized NAV return has been similarly poor at -4.1% and +2.7% (-4.5% and 2.6% in market price terms), respectively. On a relative basis, the fund has also underperformed its benchmark MSCI China Financials 10/50 Index, though the tracking error has been minimal after accounting for fees. Compared to the broader Chinese indices, though, CHIX's resilience is clear - the fund has suffered limited drawdowns through the last year, outperforming the downtrend in other US-listed China ETFs like the China iShares MSCI China ETF ( MCHI ) running and its consumer ETF counterpart ( CHIQ ).

Where CHIX continues to stand out is its semi-annual distribution, which tends to remain steady through the cycles, supported by the cash flow generators in the fund's banking and insurance portfolio. Even after the YTD rally, the yield screens very attractively at 4.7%, and with a beta of 0.29 vs. the S&P 500 ( SPY ), the ETF presents a great defensive option for income investors. The added bonus is the portfolio's steep valuation discount on virtually all fundamental metrics - the fund trades at ~5x fwd earnings and ~0.6x fwd book, leaving ample room for a further re-rating in the coming months.

Valuations Nearing Trough Levels for Chinese Financials

There is value emerging from the Chinese banking sector, particularly the large SOE banks, which trade at historically low 50-60% discounts to their underlying book value despite maintaining strong capital positions and consistent ROEs in the low teens. While there are still systemic risks that come with investing in China, banks' valuations have likely discounted this and then some. In the meantime, many of China's major state-owned banks also offer stable high-single-digits % dividend yields, well above comparable bond proxies domestically and overseas. Assuming yields eventually normalize toward the telcos' low to mid-single-digits %, this implies significant upside as the market reprices the Chinese banks over time. Beyond the large banks, higher beta banking plays in the regionals, as well as investment banks/brokers, also offer an interesting risk/reward as the consumer-led recovery gains further traction. And with the rate cut cycle likely at an end, the path is clear for an eventual P/B re-rating for the CHIX portfolio.

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