Many financial advisers and investors are concerned about the risks in holding equities of China-based companies following a series of crackdowns this year that have erased billions of dollars from the value of U.S.-listed Chinese firms.
The latest regulatory move involves a ban on for-profit tutoring, which resulted in some public companies’ value plummeting precipitously. For example, Tal Education Group TAL-N, an industry leader in the after-school tutoring market in China, lost 92 per cent of its value this year.
China’s State Administration for Market Regulation fined Alibaba Group Holding Ltd. BABA-N a record US$2.8-billion this past spring for abusing market dominance. That was a few months after regulators halted an initial public offering (IPO) by Alibaba’s wealth management affiliate, Ant Group, at the last minute.
In June, days after ride-hailing giant Didi Global Inc.’s DIDI-N American depository receipts began trading on the New York Stock Exchange, Chinese regulators ordered the company’s app to be taken down because of security issues.
It all appears to be very bad news for an emerging-market exchange-traded fund (ETF) weighted heavily toward China. But for Kevin Carter, founder and chief executive officer of the Emerging Markets Internet & E-commerce ETF EMQQ-A in Lafayette, Calif., it’s the reverse. He sees it as a welcome sign that regulators are doing their jobs.
“This is the largest panic I’ve seen since we launched the fund in 2014,” he says. “But the U.S. lens is so jaded when it comes to China, everything that happens is viewed with mistrust.”
The ETF has US$1.7-billion in assets under management, of which almost two-thirds are invested in Chinese companies. It’s down 15 per cent year to date and 36 per cent from its February high. In 2020, Morningstar Inc. ranked the ETF first out of 796 funds in its category. In 2019, it was ranked second out of 835 funds.
Mr. Carter spoke about the impact of China’s recent regulatory moves, his optimism about that country, and emerging markets more generally, in an interview with Globe Advisor.
Why are you bullish on emerging markets?
Emerging-market consumers are the tip of the spear of world growth. Why? Because the thing that’s emerging is them. Their incomes are growing and they want stuff – more and better everything.
What are the big trends?
As mentioned, No. 1 is the rise of emerging-market consumers. Emerging markets have 85 per cent of the world’s population and almost 90 per cent of the young people. The second trend is their use of smartphones. For most of them, their first computer is a smartphone. That’s combining with the third trend, which is the availability of the internet. When you put those three together, you have enormous power.
These consumers are leapfrogging traditional consumption and becoming consumers as digital natives. The place you see this most powerfully is in financial services. They don’t have bank accounts or debit cards. There’s no store to go to even if they had a car. It plays out differently in different places, but more than half the mobile pay users in the world are in Africa.
How quickly is this happening?
In the 10 years ended Dec. 31, 2019, the average annual revenue growth in emerging-market internet and e-commerce was 38.5 per cent. I think it will continue to be the fastest-growing global sector.
What is your strategy for the ETF?
It’s very simple: We will invest in any internet or e-commerce company in any emerging or frontier market as it meets our minimums for size and liquidity.
Currently, there are 118 of those companies. We have an 8-per-cent limit on the largest holding. That’s largely because Alibaba and Tencent [Holdings Ltd.] TCEHY are significantly larger than everything else. We rebalance in June and December.
How should investors view recent actions from China’s regulators?
Regulators have pulled the emergency brake, tightened up the rules, made sure everyone knows them, and pushed the restart button. The Chinese understand capitalism better than anybody. They know it works. It has lifted them out of poverty. The problem is that anything to do with the Chinese government becomes a worst-case scenario when viewed through the U.S. lens.
So, how do you look at it?
Last November, when regulators pulled the Ant Group’s IPO, the more I looked at it, the more convinced I was that they were right.
The Ant Group platform sells wealth management and insurance, mutual funds and makes loans. It was originating more loans than anybody else in China, but it wasn’t regulated like a bank. That made Ant Group incredibly profitable but created unacceptable levels of risk.
As well, the entire sector had grown at an incredible rate and regulators were having trouble keeping up with it. So, they pressed the brake. The message was: “We’re revising the rules and we’re going to enforce them.” It was smart.
What about the latest crackdown on education?
The Chinese place a high value on education. The demographics are such that there are two sets of grandparents and two parents. The child is all they have. So, the pressure is super intense, with negative side effects: kids spending too many hours a week on extra studying and a wild west show with people borrowing money to pay and cheating scandals.
What’s your outlook for the emerging market e-commerce?
Investors with a three- to five-year time frame will do very well, but not without volatility. We’ve had many 30-per-cent declines and we’re having one right now. We will have more, but they’ve always been good times to buy.
Adam Mayers is a contributing editor to the Internet Wealth Builder investment newsletter.