China ETFs see a surge of buying – is buying the dip too risky?

The tech crackdown in China is viewed by many as a potential buying opportunity. 

The biggest story moving markets and funds in July was the so-called tech crackdown in China. As I explain in more detail here, there are multiple aspects to this. Large Chinese technology companies are being investigated for monopolistic practices, while the future of Chinese companies listed on US stock exchanges has been thrown into doubt. On top of this, Chinese authorities are trying to scale back a large tech-enabled education sector.

All this has taken a toll on Chinese equities, with many major indices posting double-digit losses. As you would expect, the exchange-traded funds (ETFs) that track these indices have also felt the pain.

However, while Chinese equities have seen major price declines, for many investors this is not major cause for concern. Instead, many have seen the fall in price as a buying opportunity.

This is demonstrated in the buying choices of interactive investor customers. In June, the HSBC MSCI China ETF (LSE:HMCH) was the 82nd most-purchased ETF on the platform. However, in July it shot up to the 21st most-bought ETF. This ETF tracks the MSCI China Index, which is heavily weighted to some of the most affected companies. Its top three weightings are Alibaba (NYSE:BABA), Tencent (SEHK:700) and Meituan (SEHK:3690).

Even more spectacularly, the iShares China Large Cap ETF USD Dist USD (LSE:IDFX) went from being the 253rd most-bought ETF in June to the 59th most-bought in July. This ETF tracks the FTSE China 50 Index. Its largest weightings are similar to the MSCI China Index.

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Investors also snapped up the KraneShares CSI China Internet ETF USD (LSE:KWEB). This ETF has been the most affected by the tech crackdown due to its specific focus on overseas-listed Chinese tech companies. On a one-month basis, it has lost around 20%. However, many investors seem unperturbed. In July, it was the 48th most-purchased ETF on interactive investor, up from 106th most-bought in June.

‘Buying the dip’

Many investors are “buying the dip”. The idea of treating sell-offs as a buying opportunity has become increasingly ingrained in recent years. Investment books implore readers to treat price declines as stocks “going on sale”. Countless studies and articles have documented how markets tend to overreact, creating cheap buying opportunities. The message taken is that, over the long term, asset prices recover, meaning dips are opportunities to enhance gains.

Often this is sound advice. Over the past few decades, US markets have experienced several severe sell-offs, be it because of the financial crises, economic growth scares, fears of central bank rate rises, or a global pandemic. Each time, the US market has bounced back, giving those willing to buy the dip handsome returns. ETFs also make this easier, allowing investors to easily buy the entire market.

Perhaps investors are making the right choice here. Markets are notorious for overreacting. And indeed, several of the Chinese companies and ETFs have been staging a recovery from the depths of their July falls, albeit they still sit at a loss from their peaks.

Political risk rethink of investing in China

However, for many professional investors, the recent behaviour of the Chinese government has led to a rethink about the political risk of investing in China. While some prices have started to recover, the technology crackdown has proven to some that the Chinese authorities are more than prepared to sacrifice the shareholder value of their largest companies to pursue their own policy goals.

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The most acute example of this is education and digital tech. In their attempt to reduce education costs for Chinese families, the government has almost decimated some very valuable companies. On top of this, the wider tech crackdown may not be over, meaning prices continue to fall. The Chinese authorities are still investigating companies for monopolistic practices, while the issue of foreign stock exchange listings is still far from resolved. At the very least, for many investors the recent sell-off has shown that the policy decisions of the opaque Chinese Communist Party can lead to huge and swift price declines. This is a far cry from buying stocks during a sell-off caused by central bank rate rises, or fears about weaker economic growth. 

The China ETF that held up during the sell-off

Interestingly, the iShares MSCI China A ETF (LSE:CNYA) has also experienced an increase in demand. In July, it was the 82nd most-bought ETF, up from 170 in June. What makes this interesting is that the ETF tracks the MSCI China A index. This index is composed of Chinese A-shares, meaning companies that are listed on domestic Chinese exchanges.

As a result, the index has no exposure to foreign-listed companies, which have been harmed. This also means that it has less exposure to the sort of big tech companies that have been in Beijing’s firing line, such as Alibaba and Tencent. Therefore, the index has held up relatively well. On a one-month basis, the index’s returns are flat (total return in sterling terms). In comparison, the broader MSCI China index, which includes overseas listed companies, is down 5.5%. On a three-month basis, the A-shares index is up 5.4% and the broad MSCI China index is down 5.3%.

So why are more investors buying this A-shares index tracking ETF? There are two potential explanations. First, investors may not realise the ETF tracks a comparatively unaffected basket of stocks. The different share classes and indices for Chinese equities can be confusing. Many investors may mistakenly think they are buying the dip when they are buying iShares MSCI China A ETF (LSE:CNYA).

More generously, investors may be shifting their China exposure. Rattled by the Chinese government’s crackdown on tech and foreign-listed firms, some investors may be speculating that the safest way to gain China exposure is with an index made up only of domestic-listed companies. As noted above, the index is also less tech heavy. Its biggest holding, for example, is a drinks producer. Such companies, some investors might hope, will provide access to China without the risk of further tech crackdowns.