Friday, 1 June 2012

Chinese Equity ETFs

Investing in Chinese Equities

For a lot of investors exposure to emerging markets and particularly China is appealing. The easiest way for an investor to invest is by buying a mutual fund that invests in a broad range of Chinese stocks. Personally I prefer to buy low cost ETFs than a more expensive mutual fund that is unlikely to do any better. One such ETF is ishares FTSE China 25 (FXC.L) which has a total expense ratio of 0.74% pa (not the cheapest of ETFs it's true).



To value the current attractiveness of this fund we will use a similar method to valuing shares (see Selecting and valuing individual stocks).


Dividend Yield

The gross dividend yield for this fund will be the distribution yield plus the total expense ratio. Looking at the ishares website I get a distribution yield of 1.92% which will give a gross dividend of 2.66%.

Growth Rate

For the growth rate we can use the Real GDP growth rates from the IMF World Economic Outlook April 2012. They estimate a Real GDP growth rate of 8.2% in 2012 and 8.8% in 2013. Taking an average we get 8.5% real growth. As a margin of safety we will half this giving us a real growth rate of 4.25% pa.

As these are real growth rates we need to convert them to nominal to include inflation (this is mainly so that when we are comparing investments across different asset classes they are compared on a level playing field). If we use 2.5% as our inflation estimate then we get a nominal growth rate of 6.75% a year.

Adjustment Rate

If you remember for valuing individual stocks we used 5.5% as the historical dividend yield. For funds we can be a bit more generous as they are less risky than individual stocks. Let's use 4.5% as the historical yield.

Adjustment Rate = ((Gross Div / Historical Div) ^ (1/20)) - 1
= -2.59% a year  


The Verdict

The above figures give us a total annual expected return of:

Gross Div + Growth Rate + Adjustment Rate - TER
= 2.66% + 6.75% - 2.59% - 0.74%

= 6.08% a year

Not a terrible return admittedly, but it could be better. 

Looking at the price chart for FXC.L the 100 day low was recently broken suggesting a possible downtrend could continue. For funds, especially big ones such as this, technical analysis isn't so important for a long term investment. You could wait and see if you can get it at a better price if the trend continues which would of course increase your expected annual returns on your investment or you could look for more profitable opportunities elsewhere.

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