Following Buffett Down the China Expressway
Nick is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Prior to joining Global X Funds, Alex Ashby lived and traveled extensively throughout Asia. He currently manages a group of six ETFs covering the consumer, energy, financial, industrial, materials, and technology sectors of the Chinese economy. The Global X China Industrials ETF (NYSEMKT CHII) provides investors with exposure to industrial companies in China and is designed to be a transparent, cost-efficient way to get access to the growing demand for energy within the country.
Nick Slepko: The companies in the China Industrials ETF seem the least motivated to attract international investment – only three of the stocks have bothered to create ADRs.
Alex Ashby: Well one thing worth noting is that issuing a sponsored ADR is not a simple one-off process – it can actually require a significant amount of resources for the company to maintain the ADR program, and also create additional compliance and regulatory requirements on the side of the company as well. For industrial companies in China whose main customer is the Chinese government, listing and maintaining an ADR program may not be the best utilization of resources, and I think that is at least partly why you don’t see many ADRs listed for these types of companies. The other reason is that many of these industrial companies may not be familiar to investors since their business is done almost exclusively in China – this could affect potential demand for the ADR itself. However, the lack of ADRs for industrial-focused companies highlights one of the benefits of the ETF, because it allows investors to access these local companies that do not have listings in the US.
Slepko: Probably the only Chinese industrial stock most people are aware of is the battery and auto maker BYD (NASDAQOTH:BYDDY) which is best known for being Warren Buffett’s most counter-intuitive purchase – as it is somewhat tech and very foreign. However, true to Buffett legend, Berkshire Hathaway’s (NYSE BRK-A)(NYSE: BRK-B) subsidiary MidAmerican acquired its 10% share at one of its lowest points in the stock’s share price history, and has held on to it for the last four years through boom and re-bust. How does BYD fit into the overall China industrials picture?
Ashby: BYD achieved initial success by capturing a significant share of a rapidly growing market – rechargeable batteries for mobile phones. They have since used their expertise in manufacturing and battery making to expand in to other areas like autos, which is another high growth area in China in particular. While it may seem like an unusual Buffett investment, if you boil down Buffett’s strategy it comes down to value investing – as you mention, MidAmerican acquired its share at one of the lowest points in the stock’s history. While it is somewhat of a tech story, Buffett has acknowledged that in the case of BYD there were other factors that trumped his typical “invest in what you understand” concept. By his own accounts, Buffett had enough confidence in the management and the market opportunity – not to mention whatever valuation analysis that was done – that a complete understanding of all the technology wasn’t necessarily needed to justify the investment. While the value of Buffett’s investment has fluctuated, at current prices it has still been a profitable one. BYD has faced increased competition and a slower domestic economy over the past year, so the company’s performance will likely be affected by a potential rebound in China’s economy and the ability of BYD to execute on its strategy.
Slepko: Coincidentally, Buffett’s acquisition occurred less than two weeks before the SEC allowed the creation of unsponsored ADRs [10 October 2008]. Through out the fourth quarter of 2008, Bank of New York Mellon (NYSE: BK) was particularly zealous in creating the majority of the 600 new unsponsored programs, one of the first of which was BYD (though the process required them to have been preparing long before Buffett announced his intentions). [Essentially, the SEC decree allowed foreign companies with English language financials and information on their websites to be traded OTC.] Also, considering the recent shenanigans with major auditing firms and listed/quoted Chinese companies in the US, can you tell me more about how the ETF and its indexer, Structured Solutions/Solactive, assess and incorporate ADRs?
Ashby: In the case where a security has both a local listing and an ADR, the key question is one of liquidity. While each index provider may operate differently, typically during the original index construction the provider will determine which listing of the security (local versus ADR) offers the most liquidity and then will determine the index holdings accordingly – assuming the security meets the other guidelines for inclusion in the index. As the fund manager of passive ETFs, our mandate is to track the underlying index. Typically the easiest way to do this is to hold the same listing of the security as the index. However, because the ADR will track the performance of the local listing, as the fund manager in these cases we have some flexibility to determine which listing is most beneficial for shareholders from a cost/liquidity perspective. One example would be if the index holds the local listing but the liquidity of the local listing declines for some reason and the ADR becomes more liquid – in this case, if the ADR becomes more cost effective to achieve the same exposure then the fund could access the security through the ADR rather than the local listing. However, this is a relatively uncommon scenario and typically the fund will hold the same listing as the index. Of course, each index provider is slightly different so the determination of the ADR/local listing will depend on the index provider as well as the specific characteristics of the index in question.
Slepko: Are Guangshen Railway (NYSE: GSH) and Jiangsu Expressway (NASDAQOTH: JEXYF) unique entities in the Chinese economy, or are these private infrastructure concerns the sort of enterprises that are typical in modern China?
Ashby: One way to think about these companies is how they fit into the government push for urbanization and development – China continues to focus on integrating the rural interior with the more productive coastal areas, and both railway and highway links are a key part of this integration. Guangshen Railway is involved in both passenger and freight transportation, and is expected to benefit from growth in these areas and any accommodative policies for infrastructure development from the government. Jiangsu constructs and operates expressways, which is a different business than railways but which is expected to benefit from similar trends of urbanization. Both of these companies are targeted domestic plays on continued growth in China – a slower economy in 2012 was reflected more or less directly by a slowdown in passenger traffic growth for both Guangshen and Jiangsu. It will be interesting to see how the new leadership in China attempts to jumpstart the economy, as any sort of major infrastructure project announcements would be noteworthy for both Guangshen and Jiangsu. Although [CHII] is not exclusively an infrastructure play, many of its holdings provide exposure to continued infrastructure development in China and the “on the ground” growth story happening in the country, which is often a different type of exposure than investors might receive through other China-focused ETFs.
Nick Slepko (hukgon) has no position in any company mentioned here at the time of publication. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!