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Introduction
On 13th April 2021, we had published an article: “China Tech Stocks are down 27% since Feb 2021, should you invest now?”
As long-term investors, we do see a strong basis for building up exposure to China Tech stocks now. While fundamental risks to the sector remain elevated, we believe they have already been priced into current valuations and we would personally be gradually accumulating from here. At the margin, we see some of the key risks receding, and this may catalyze stock price consolidation for the sector.
In this article, we reveal which ETFs are optimal for investing into the sector, and the China Tech stocks with the highest implied upside to analyst consensus target prices.
Article Summary
1) Best ETFs for China Tech exposure
2) For SGD Investors: Lion-OCBC Securities Hang Seng TECH ETF
3) Which ETFs would we invest in?
4) China Tech Stocks with the largest implied upside to analyst consensus target prices
1) Best ETFs for China Tech exposure
Investing in China Tech stocks via ETFs can be relatively complex. There are nuances to index construction methodology, and the understanding of what constitutes “tech” might differ across various index compilers.
For example, many consider Alibaba to be one of China’s largest Tech companies and an investor might be keen to get exposure to it…but did you know Alibaba is NOT held by a number of China Tech ETFs, such as the widely used Invesco China Technology ETF (CQQQ US), or the Global X MSCI China Information Technology ETF (CHIK US)?
Hence, we have shortlisted 4 China Tech ETFs that cater to varying investor preferences, such as:
- Business model: Software vs Hardware tech stocks
- Listing venue of the stocks held by the ETF: ADRs vs A-Shares vs H-Shares
- Where the ETF is traded and the currency it trades in: USD vs HKD
Our 4 shortlisted China Tech ETFs are…
- Invesco China Technology ETF (CQQQ US)
- Global X MSCI China Information Technology ETF (CHIK US)
- KraneShares CSI China Internet ETF (KWEB US)
- iShares Hang Seng TECH ETF (3067 HK)
In the below image, we list the ticker codes of the shortlisted ETFs in yellow font, the type of stocks the ETF can invest in, the number of stocks held by the ETF, the ETF’s investment mandate, and the currency that the ETF trades in.
To explain briefly on the “stock types”, American Depository Receipts (ADRs) trade on US stock exchanges and denominated in USD, A-shares are listed on Mainland China stock exchanges, while H-shares are listed on the Hong Kong Stock Exchange.
We will provide a quick comparison between the 4 selected ETFs, in terms of their portfolio holdings and how they have performed historically. You might be surprised at how different they are.
Portfolio holdings
The chart below shows the top 10 stocks held by each ETF, and its cumulative weightage. The top 10 holdings currently comprise at least half of the ETFs’ underlying portfolio weightage, so you can more or less get a good feel of what you are investing in simply by looking at the below.
The general business description of each stock is included in blue font, and I have highlighted what may be considered as “hardware” tech stocks in yellow. This gives us a better idea of whether the ETF is bias towards “software”, “hardware” or a blend of both.
Historical Performance
China Tech stocks have done phenomenally well since March 2020. The below chart shows the cumulative price performance of the 4 shortlisted ETFs since 2019, and even with the recent price correction, they remain above their respective peaks set during pre-Covid.
We see this as a consequence of firms starting to prioritize digital transformation, which has accelerated the growth of various tech sub-sectors, as opposed to a tech bubble. The reason we say this is because current valuations have been driven by sales and earnings growth, and sector valuations are at a discount to the historical average (see our previous article for the compiled statistics).
In the below table, we list the historical performance, dividend yield and inception dates of the respective shortlisted ETFs.
We have also included how much these ETFs have declined in price (highlighted in orange), from their respective peaks in February 2021.
How cost-efficient are these ETFs?
In the below table, we list some important details of the shortlisted ETFs, including its current market cap, total expense ratio, average daily traded volume, bid-ask spread and domicile.
We highlight certain elements of these ETFs that we deem relatively less desirable in light red. We have highlighted:
- AUM less than US$100M
- Total expense ratio more than 0.5%
- Daily traded volume less than US$1M
- Bid-ask spread more than 0.5%
- ETF domiciled in US
Should you be concerned about dividend withholding taxes for using US-domiciled ETFs?
For Singapore investors, all things equal, it’s better to buy a SG, HK or Ireland-domiciled ETF if you are planning to invest for the long-term. Choosing to invest in China companies via US-domiciled ETFs will subject you to a 37% effective dividend withholding tax, which is generally undesirable (for more details, you can read our article on dividend withholding taxes).
However, the US-domiciled ETFs we shortlisted can still be optimal, as these ETFs have generally low dividend yields of less than 1%, so the impact from dividend withholding taxes is less significant.
Later on in Section 3, we will discuss which of the above ETFs are most suitable for different investor profiles.
2) For SGD Investors: Lion-OCBC Securities Hang Seng TECH ETF
A common gripe among SGD investors is the lack of high growth tech stocks listed on SGX. These investors would be pleased to note that they now have a solution, with the recent listing of the Lion-OCBC Securities Hang Seng TECH ETF.
This ETF provides similar investment exposure as the iShares Hang Seng TECH ETF (3067 HK), and invests in the largest 30 tech-related stocks listed on the Hong Kong Stock Exchange. The key difference is that it’s tailored for the Singapore market, and hence offers both a SGD-denominated share class and a USD-denominated share class.
How cost-efficient is the Lion-OCBC Securities TECH ETF?
In the below table, we compare the Lion-OCBC Securities TECH ETF against the iShares Hang Seng TECH ETF. While the former has a slightly higher total expense ratio, it would still make sense for investors who:
- Want to keep their investments in SGD
- Are keen to invest their Supplementary Retirement Scheme (SRS) in a longer-term growth theme – Lion-OCBC Securities Hang Seng TECH ETF is a SRS-eligible investment
3) Which ETFs would we invest in?
Investing is very personal, so we believe that the best ETF to invest in would depend on one’s personal situation and investment preference. For example:
- For a long-term investor who prioritizes diversification, pairing “KWEB” with “CHIK” can be considered since there are virtually no overlaps in their top 10 holdings.
- For a long-term investor who wants diversification while investing in only 1 ETF, “CQQQ” can be considered, as it provides a good mix of software and hardware stocks, and is invested across ADRs, A-shares and H-shares.
- For investors who wish to keep their investments in SGD, the Lion-OCBC Securities Hang Seng TECH ETF can be considered.
- For short-term traders or investors who plan to invest relatively larger sums, AVOID using “CHIK” as it has a relatively wide bid-ask spread and poorer liquidity.
Personally, with the recent sell-off, we have been accumulating “CQQQ”, “KWEB” and “3067 HK”, and planning to invest in the Lion-OCBC Securities Hang Seng TECH ETF using our SRS (where investment options are more limited).
4) China Tech Stocks with the largest implied upside to analyst consensus target prices
For single stock investors, we include a list of the largest Chinese “Software / Online” stocks, and a list of the largest Chinese “Hardware” stocks below. Both tables have been sorted by their implied upside to analyst consensus target prices (rightmost column), with stocks at the top of the lists having the highest implied upside. Do note that the China tech stocks in these lists are not exhaustive.
Other fundamental data such as the forward P/E, P/B and dividend yields have also included in the below tables.
And for investors screening for stocks that have pull backed the most in the short-term (from their peaks within past month), do look at the column “% Chg vs 30D Hi” in the middle of the table.
Which stocks are we looking at?
In our previous article, we identified 4 factors that has contributed to the China Tech sell-off, one of which was the Archegos blow-up.
During the blow-up, there was a forced liquidation of Archegos’ portfolio holdings, which included significant exposures in Baidu, Tencent Music, Vipshop and iQIYI. As the damage seems to be contained and fundamentals of these companies have not changed, some investors might take the view that the sell-off in these stocks is technical and short-term in nature.
Personally, we will be taking a closer look at Baidu for several reasons:
- Visible short-term growth: Cloud computing exposure
Not many people think of Baidu as a high growth “Cloud Computing” company. However, keep in mind that Baidu’s 4Q2020 cloud revenues annualized US$2 billion with 67% year-on-year growth.
Some investors buy Alibaba for its cloud segment, as Alibaba Cloud has the largest market share of ~40% in China. Alibaba Cloud’s 4Q2020 revenues annualized US$10 billion with 50% year-on-year growth. The revenue from Baidu’s cloud segment is 20% of Alibaba’s, while the market cap of Baidu is 11.4% of Alibaba. So, wouldn’t an investor get relatively more exposure to Cloud by buying Baidu?
Of course, investors may choose to invest in a smaller pureplay China cloud stock like Kingsoft Cloud at about 10x Price-to-Sales. At these valuations, it would imply that Baidu’s current cloud division could currently be worth about US$20 billion (or 27% of Baidu’s current market cap), which is significant.
- Longer-term opportunities: Autonomous vehicles / Electric vehicles
Similar to Waymo (Google’s autonomous driving unit), Baidu also has an autonomous driving unit called Apollo, which leads China’s automous driving space. Apollo’s autonomous Robotaxi is currently being tested across 6 cities (Beijing, Shanghai, Guangzhou, Chongqing, Cangzhou, Changsha), and open for public use in three of them on a small scale. Moving forward, Baidu plans to expand its Robotaxi services to 30+ cities in 2023, with 3,000 autonomous vehicles. You can see Baidu’s Robotaxi in action in the below video.
Separately, Baidu has concurrently entered a joint venture with Geely (which owns Volvo) to co-develop EVs, for targeted release in the next 3 years. It’s a logical partnership where Geely brings the manufacturing expertise, while Baidu brings the software / AI expertise. We can also imagine these EVs will have potential synergies with the earlier mentioned Apollo business unit.
Quoting from a report published by JPM on 28 March 2021, “…Baidu’s autonomous driving operation could be worth US$99 billion today if it captures 20% market share in both commercial transportation and intelligent car solution markets (10 years from now)…At a more optimistic net margin assumption of 30%, Baidu’s autonomous driving solution could be worth US$200 billion today.”.
For context, Baidu’s market cap is currently US$74 billion…which also includes its core ad business, Cloud / AI business, stakes in Trip.com, Kuaishou, China Unicom and iQiyi.
- Baidu still trades like a value stock
Baidu’s valuations are inexpensive in our view at 22x forward P/E, factoring in the growth engines that augment Baidu’s core advertising business. And like many software tech firms, Baidu also sits on a sizable net cash position of ~US$12 billion (16% of current market cap).
These factors may help to provide some support, in the event of further share price declines across the broader China tech sector.
Just in case you want to see how Baidu compares to its software sector peers, here’s a repeat of the valuation table of China’s “software / online” stocks. Baidu is the second stock from the top.
The InvestQuest View:
As long-term investors, we do see a strong basis for building up exposure to China Tech stocks now. While fundamental risks to the sector remain elevated, we believe they have already been priced into current valuations and we would be gradually accumulating from here. At the margin, we see some of the key risks receding, and this may catalyze stock price consolidation for the sector.
In this article, we shortlisted 4 ETFs we deem optimal for investing into the sector, and revealed the China Tech stocks with the highest implied upside to analyst consensus target prices. We believe that Baidu warrants a closer look.
Would it make better sense from withholding tax perspective for international investors (non-US) to invest in 3186 HK instead of KWEB US for the similar CICC KraneShares CSI China Internet ETF?
Noted that Chinese Investment Bank (CICC HKSE 3908) bought a controlling interest in KraneShares and thereafter listed the KWEB shares on the Hong Kong Exchange as CICC KraneShares CSI INTERNET ETF (HKSE 3186).
Yes, 3186 would be marginally better than KWEB from a withholding tax perspective but the actual savings isn’t much at less than 0.1% p.a, since KWEB only has a dividend yield of 0.3%.
I would personally avoid 3186 for now since:
1) Mkt cap is still very low at US$10M. A possible implication is that the ETF provider finds this unprofitable and decides to close it down, and you might end up liquidating at a bad market timing. A second implication is that there’s hardly any volume traded, which opens the risk for a big price gap risk during purchase/sale of this ETF.
2) HK stamp duty of 0.1% will apply to 3186, which would not have been applied to KWEB.
would you consider the HK listings for Baidu and Bilibili?
Yes, I’m indifferent between the HK-listing and ADR for both stocks, since both their ADRs and H-shares are sufficiently liquid for individual investors. There also isn’t a divergence in valuations currently.
For example, Baidu’s HK-listed closed at HK$210.60 today, and its ADR (which represents 8 shares of Baidu) opened at US$216.21 in the US market. Using the current USD/HKD FX rate of 7.766, assuming all things equal, we would have expected Baidu to open in the US market at 210.60 * 8 / 7.766 = US$216.95. So the price difference is very marginal and more a consequence of market movements between the time HK closes and US opens.
For Bilibili, it closed at HK$809.50 today, and its ADR (which represents 1 share of Bilibili) opened at US$104.36. Using the current USD/HKD FX rate of 7.766, assuming all things equal, we would have expected it to open in the US market at 809.50 / 7.766 = $104.24. Again, we don’t see much price difference.