VanEck’s Australian arm is listing a new smart beta fund that will hunt in China’s A shares bin for ‘growth at reasonable price’ stocks. The VanEck Vectors China New Economy ETF (CNEW) will track an index built by CSI, the biggest Chinese index provider, and MarketGrader, a Florida-based research house.
The index starts with the 2,000-plus universe of China A-shares, which are screened for basic liquidity. It then applies its smart beta screen, which eyes companies’ growth, value, profitability, and cash flow, with the objective of identifying “securities that offer the best potential for ‘growth at a reasonable price'”, VanEck said on their website.
Companies are then graded, with the top 30 from each of the following four “new economy sectors” included in the index:
- Consumer Discretionary; and
- Consumer Staples.
The portfolio is equally weighted with rebalancings taking place twice a year.
Analysis – tax: what’s going on?
China ETFs are a logical choice for Australian investors. Most educated Australians have some familiarity with China: its politics, geography and language. And all Aussie investors understand the importance of Chinese growth for Australia’s economy. There is near universal consensus among Aussie investors that – long term, at least – China is a buy.
Yet China ETFs in Australia have been beset with a number of difficulties. The most crucial is tax. Most China ETFs have been domiciled in the US and cross-listed over to the ASX. This means they get their dividends taxed by two separate foreign governments before they even arrive in Australia. The PRC takes 10% of dividends paid out by Chinese companies to foreigners. While the US government takes 15% of the dividends paid by US-domiciled funds to foreigners. Taken together, this means Australians lose 25% of their dividend cheque to foreign governments.
These taxes blunt the incentives for value investing and buying the dip. Dividends, as we all know, are a function of value. A large dividend cheque – like a large junk bond coupon – is typically a reward for higher risk. (Safe companies with high dividend yields will pretty quickly find their share prices bumped up and yields correspondingly lowered). But high dividend taxes erode this incentive, which is problematic for China ETFs at present, because China is currently dipping.
The great strength of CNEW is it’s Aussie domiciled – meaning Australians will only have to pay Chinese (and Australian) taxes.
The other difficulty for China ETFs has been, well, China itself. Donald Trump’s trade war; the 2015 bubble; the unpredictable Communist Party; the fat stash of private debt; empty skyscrapers and malls; white elephant infrastructure projects; the list goes on.
These risks have very probably been overstated. Yet the perceptions remain.
It will be interesting to see if the ‘New Economy’ smart beta twist VanEck is putting on this index can lure in investors in these difficult times.