Chinese equities occupy an interesting position in the world’s equity markets. Few other developed countries have as tightly regulated of a market with as high volatility.
Despite the fact that many Chinese equities trade in value territory, the ramifications of political risk and over-regulation remain difficult for traders to price in. Government policies especially around continued back-and-forth COVID-19 lockdowns and supply chain issues make risk difficult for investors to gauge.
Couple this with systemic risk in the Chinese real estate market as a result of the Evergrande credit crisis and a recent contraction in the tech sector, and what you have is a very volatile, yet opportune environment for bullish and bearish traders alike to take a position in.
Trends in June and July
Investor inflows into Chinese equity ETFs surged strongly in June following signs that the country’s draconian “Zero-COVID” policies were abating, along with indicators that the government’s anti-trust crackdown on the technology sector was becoming more lenient. A combined total of $5.8 billion USD was recorded flowing into Chinese equities, exceeding records last set in January.
YTD (as of July 8th, 2022), the iShares MSCI China ETF (MCHI) is only down -11.54%, compared to the -18.70% loss suffered by the S&P 500 Index. MCHI suffered its deepest drawdown on March 15th, hitting a 52-week low of $43.59 due to a sell-off sparked by weaknesses in large Chinese web companies like Alibaba (BABA), Tencent Holdings (TCEHY), and JD.com (JD).
The earlier sell-off was precipitated by concerns about China’s ties to Russia given the latter’s invasion of Ukraine and the possibility of sanctions. In addition, regulatory concerns about possible de-listings of Chinese equities from U.S. exchanges prompted many traders to risk-off, which caused the major Chinese indices to plunge further.
Throughout 2022, the Chinese equity sell-off has affected its technology sector disproportionately. Sentiment towards Chinese tech and web companies soured amid Beijing’s crackdown on perceived anti-competitive practices. Beijing’s further unwillingness to cut interest rates given the state of the economy and market further dampened investor outlooks.
Retail disadvantages
Foreign investors looking to trade Chinese equities face significant disadvantages from both currency risk and accessibility. For the former, surges in the USD-YUAN pair can cause significant fluctuations in value for Chinese equities if purchased and held directly. This can put traders at a significant disadvantage if FX rates move against them despite the stock moving in the predicted direction.
For the latter, investors who cannot buy Chinese equities directly must rely on American Depository Receipts (ADRs) or Contracts for Differences (CFDs). These instruments allow investors to gain exposure to foreign equities without the need for currency conversion but can suffer from low liquidity and margin requirements.
An alternative is Leverage Share’s suite of physically backed exchange-traded products (ETPs). These instruments trade in USD, EUR, and GBP on local exchanges like regular equities. Compared to other ETPs that use derivatives to gain exposure, Leverage Shares ETPs are physically backed by their underlying equities, minimizing counterparty and currency risk.
Bullish and bearish traders alike can utilize Leverage Shares’ ETPs to speculate or hedge risk when it comes to Chinese equities.
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