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Chinese Tech Stocks Added into MSCI; Buy These 2 ADRs
Aspire | 07 December 2015
By: Lim Si Jie
Articles (169) Profile

MSCI has begun to add overseas-listed Chinese shares to its emerging market indexes in November, drawing billions of dollars into such stocks. MSCI Inc.’s expected decision to add US-listed Chinese companies to some of its most heavily tracked stock indexes could give a boost to China’s prominent technology champions, whose shares have seen ups and downs this year as the Chinese stock market fell from its peak. This could potentially lead to mainland-listed companies finding their way into global equity portfolios.

MSCI’s Rule Change

The move to add overseas-listed Chinese shares to its emerging market indexes is part of MSCI’s efforts to include more companies in its indexes whose shares are traded outside their home markets.

Dubbed as MSCI’s “most significant rule change” since 2008, the decision will affect China most greatly because many of its top companies are traded abroad. More than 200 Chinese companies are listed on U.S. exchanges as American depositary receipts (ADRs).

Change in MSCI China Weighting

The rule change will mean indexes like MSCI China will have a shift of weighting toward companies belonging under China’s so-called new economy. The weighting of Chinese financial stocks in the MSCI China index will drop to 35 percent from 42 percent, while Chinese Internet companies’ weighting will rise to 23 percent from 14 percent.

Benchmarking China’s Future Growth

The stock gauge’s evolution is a sped-up version of what President Xi Jinping’s government is trying to do for China’s economy: boost the role of privately-owned technology and service businesses while downsizing state-run industrial and financial giants.

Tech stocks like Alibaba Group Holding Ltd. and Baidu Inc will likely be among the 14 Chinese companies added to indexes such as the MSCI Emerging Markets Index and MSCI China, according to MSCI’s semi-annual review earlier this year.

Inclusion to Be Done In Two Phases

The current planned inclusions will take place in two phases, with 50 percent to be added in November and the rest in May 2016. According to Morgan Stanley, these newly added shares will upon completion account for 14.3 percent of the MSCI China index, or about four percent of the broad MSCI Emerging Markets index.

Trigger Buying From Tracking Funds

The move will trigger immediate buying among funds that passively track the indexes. According to Goldman Sachs estimates, $78 billion could flow into the U.S.-listed Chinese companies set for inclusion, which is equivalent to about a quarter of their current market capitalization.

ADRs Undervalued

Many U.S.-listed Chinese companies have struggled to gain attention from global investors and have suffered from low valuations compared to peers in their home markets, prompting a string of recent bids from buyout groups.

For example, Alibaba’s shares lost as much as 44 percent from their peak in late last year, but later on rebounded 30 percent from their September trough as MSCI inclusion has neared, and following better-than-expected earnings.

But overall, more investors are starting to realise that these ADRs are some of the best companies in China, and they are cheaper than their China-listed counterparts.

Investors Takeaway: 2 ADRs to Invest in China’s New Economy

1. Baidu Inc.

Baidu, Inc. provides Chinese Internet search services, similar to what Google does. The company also offers online community-based products and entertainment platforms; an instant messaging service; and a consumer-oriented e-commerce platform. In addition, it designs and delivers online marketing services and auction-based P4P services that enable its customers to enhance their search engine marketing to internet users searching on Baidu.

Investing in Baidu is a way of investing in China’s transition into a consumer-based high tech economy.

Source: Reuters

While Baidu had a poor year, its fundamentals remain strong. Its five year average margins remain a cut above its peers. The poor performance could provide a cheaper point of entry for long term investors into China’s future growth.

2. Netease Inc. (K3MD)

Netease Inc. operates an interactive online community in China and is a provider of Chinese language content and services through its online games, Internet portal, e-mail, e-commerce and other businesses. The Company operates in three segments: Online Gaming Services, Advertising Services, and E-mail, E-commerce & others.

Source: Reuters

Netease Inc too possesses strong fundamentals, with both its TTM and five year average margins superior to industry and sector benchmark.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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