NIO - PGJ: Challenged Performance Even Considering The Pandemic

2023-10-11 05:36:02 ET

Summary

• Invesco Golden Dragon China ETF has seen negative returns of 11.2% over the past decade despite China's growing economy.
• The fund has been impacted by the extended pandemic effects, US-China tensions, and uncertainty about China's economy.
• While there have been some recent performance improvements, it's still not competitive against other options in the market on multiple metrics.

Here's a puzzling fact about the Invesco Golden Dragon China ETF (PGJ). The fund invests 90% of its assets in stocks that get most of their revenue from China. Yet, while the size of China's economy has more than doubled in the past decade, returns from the ETF have actually reduced investors' capital by 11.2% over this time.

Here, I explore what's holding PGJ back and whether it has now touched such a low that the only way might just be up.

What's holding PGJ back?

The macro context

Some of the recent trends for PGJ are, of course, explained by the extended pandemic effects on China in the recent past. Also, the stress between the US and China has been damaging to the country's prospects. Additionally, uncertainty about its economy even post-lockdowns on account of its industrial sector and even more so real estate, has affected China's stocks.

However, things are looking up, with the Chinese government announcing supporting measures, there's also been some mending in US-China ties recently and banks are even raising forecasts for the economy now.

The investing basis

The PGJ story also needs to be seen in the context of the index on which it's based, the NASDAQ Golden Dragon China Index, which leaves little wriggle room for it to perform any differently. The fund's performance of course is very similar to the index (see chart and tables below).

Further, its performance is also similar to the benchmark index it compares with, which is the FTSE 50 China Index. This benchmark represents China's 50 blue chip stocks. Seen in the context of these indices, PGJ's performance looks less glaring.

COVID-19 impacted industries

PGJ has also likely been disproportionately impacted by COVID-19 regulations in China until late last year, from which it hasn't recovered. This is because the focus industries for the fund are (i) broadline retail (ii) hotels, restaurants and leisure (iii) interactive media and services and (iv) automobiles, all of which have a 10-20% weightage in assets (see chart below).

Can PGJ recover now?

This raises the next question. Now that China is doing much better, and recent initiatives by the government have also alleviated some concerns about the slowdown there, can the fund do better?

Yes and no, would be the answer. Let me elucidate.

Improving performance

As far as the positives go, the fund has given price returns of almost 16% over the past year. This isn't too bad and reflects a recovery in China's stocks. In fact, four of the fund's top five holdings (see table below), with over 35% weight in total assets, are rated either Buy or Strong Buy by both Wall Street analysts and Seeking Alpha analysts. The only exception is the electric vehicle [EV] company NIO ( NIO ), which gets mixed ratings.

In fact, NIO is one reason why the fund's returns have been dragged down considering that it has declined by 37%. It's not alone, though, in the decline. The fourth largest holding, the retailer JD.com ( JD ) with a 6.6% share, has also seen a 39% decline. That said, buoyed to some extent by its biggest three holdings, Yum China ( YUMC ), Baidu ( BIDU ) and Alibaba ( BABA ) (see chart below). On the whole, in the past year, the performance has been more encouraging than not.

The downside

Comparison with China's stock markets

However, China's a big market as we all know, which offers plenty of choice to investors who want to buy into the market. While it's some solace that the fund has performed in line with its benchmark index, broadening the comparison reveals continued underwhelming performance.

I compared PGJ to the Shanghai Composite Index ( SHCOMP ) and also the Global X MSCI China Consumer Disc ETF (NYSEARCA: CHIQ ) since over 50% of the fund's allocations have been to consumer discretionary stocks. Over the past decade, SHCOMP actually delivered over 40% returns and even CHIQ's returns are also superior to the fund at 10.5%. In other words, whether we look at the broader markets or sector-specific performance, PGJ is indeed lagging over the long term.

Unattractive market multiples

PGJ's market multiples, as measured by the price-to-earnings (P/E) ratio, aren't competitive either. At 25x , its P/E is double that for SHCOMP at 12.5x and even higher than that for CHIQ at 18.5x . A high P/E combined with a lagging long-term performance isn't a good combination. And indicates that the gains made over the past year might not continue.

Low dividend yield

Its dividend yield doesn't come to the rescue either. Its trailing twelve months [TTM] yield is at 1.3%, which is lower than the median of 2.6% for all ETFs. Even the yield on cost over the past two decades is low at 2%. It doesn't help that it didn't pay a dividend in 2021 either, though that's explained by the pandemic during the period right before.

What next?

If you've bought the fund in the past year, and have made gains, this is the time to Sell. Partly because its trends aren't entirely encouraging and partly because there are better-performing options to consider when investing in the China story.

While it's true that its biggest holdings show promise, the fact remains that overall there are just too many drags on PGJ. The first is the NASDAQ Golden Dragon China Index, on which it's based. The fund is tied to the index, which itself has underperformed over time.

Next, PGJ doesn't compare well with the Shanghai Composite Index and the Global X MSCI China Consumer Disc ETF. This is both in terms of price performance and the P/E ratio. Further, its dividend yield is low too. It's hard to make a convincing case for holding it in the portfolio. I'm going with a Sell rating.

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