ETF Expert Eyes China Trio

11/26/2014 10:00 am EST

Focus: ETFs

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

Leading ETF expert Doug Fabian sees the market's best current opportunities in international market, particularly in China. Here, the editor of Successful ETF Investing discusses some recent developments impacting the outlook for China as well as three exchange-traded funds for investors seeking exposure to the region.

Steven Halpern:  Our special guest today is Doug Fabian, editor of two of the industry’s leading ETF newsletters; the Weekly ETF Report and Successful ETF Investing.  How are you doing today, Doug?

Doug Fabian:  I’m doing great, Steven, thank you.

Steven Halpern:  Thank you for joining us.  In your latest research reports, you suggested the best values maybe found now in international markets and you also point out that in your discussions with investors, as well as your own subscribers, you find that some lack proper international exposure in their portfolios.  Could you expand on those two points?

Doug Fabian:  Yes I can, Steven.  First of all, let’s talk about market evaluations and the US stock market has been on a tremendous run during the past five years, up some 170% plus as measured by the S&P 500.  

This has caused a lot of people to get on board not only here in the US, but around the world in US stocks and its driven price to earnings ratios to pretty high levels.  

Right now, by some measurements, the PE ratio of the US stock market going forward is about a 19.  This is historically at a high point.  Now, let’s compare what the US has done to other markets around the world and we know about the problem with the Japanese economy, we know about the problems in Europe, and there is, of course, a slowdown in Asia.  

A lot of the world markets are underperforming the US and don’t have these lofty evaluation levels. I just consider international markets to be much more favorable on a fundamental basis, just looking at evaluations.  Now, let’s talk about individual investor portfolios.  I am a money manager and I do, of course, have a longstanding newsletter.  

We have been publishing successful ETF investing going back to when my dad started our mutual fund newsletter in 1977, so we’ve been at this almost 35 years.  

I’ve got thousands of subscribers around the country and I just find with people, as I’ve looked at their portfolios, if I’ve had discussions with them, they’re just more comfortable in US markets, and since the US market has been performing so well, they have a tendency to have loaded up more on US stocks.

I just want to remind everybody, markets are cyclical. We go through periods of time when international markets outperform US markets and US markets outperform international markets.  I believe we’re going to start to see a shift going forward into 2015, where some international markets outperform the US market.

Steven Halpern:  Now, one area you recently highlighted is China and there has been a number of events impacting the China market, including the recently launched Connect program, which allows retail investors to invest in mainland Chinese equities.  Can you briefly explain that program?

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Doug Fabian:  Certainly.  First of all, I want our listeners to understand that China has been a country, of course, that has had phenomenal growth over the past 20 years, but it is actually a country that has a closed system.  

The Chinese government has been very involved in the financial markets over the years, and one of the things that they have done historically is they didn’t want to see overinvesting in China stocks, and then, all of a sudden, have that money pulled out from underneath the Chinese market when China goes through cyclical periods of boom and slowdowns.  They put these collars in place that would only allow certain money managers a little bit of access to the US market.  

Now, there’s big reforms going on in China and one of the biggest reforms is this Connect program where they are now opening up the Chinese equity markets to investors around the world and it’s not just retail investors, Steven.  

It is global money managers.  Global money managers, big firms like Deutsche Bank or a Barclay’s; these large money managers did not have access with large sums of money to be able to get into the China markets.  

That’s the most exciting part of this Connect program, is it’s going to allow money managers and investors from around the world to be able to invest in these tightly-held shares, they’re called A shares in China and I think it’s going to be a great opportunity for investors going forward.

Steven Halpern:  Now speaking about the A shares, one of the ETFs that you’re particularly bullish on is called DB X-Trackers Harvest CSI 300 China A shares (ASHR).  It’s a mouthful, but that’s the fund that you’re recommending as it’s tied to the Shanghai exchange.  Could you share your thoughts on that?

Doug Fabian:  Certainly.  Well, first of all, let’s go back to the name.  DB stands for Deutsche Bank, so that’s one of the largest money managers in the world.  

Harvest is one of the few firms that had a license to be able to invest in the China market over the past 15 years, so the Harvest people have teamed up with Deutsche Bank in order to create this exchange traded fund, the A share fund.

And so, I think it’s a fantastic opportunity for investors to use an exchange traded fund that has, you know, a joint co-op between two professional money management firms; one firm who has a longstanding presence in China, and when you see the number 300 in the name of an ETF, in this particular case, it means that there are 300 stocks that you’re investing in within one security.  

This security cost about 80 basis points per year, 0.8% management fee, very reasonable.  Again, I have been recommending it in my newsletter for the past six months or so, I just added to the position and I’m pounding the table, but I believe this is going to be one of the top performing exchange traded funds in 2015.  

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Steven Halpern:  With this exposure to 300 of the A shares, in effect, this is giving you broad diversification across a whole A share sector that you’re bullish on as opposed to an investor taking the risk of trying to select one of the individual stocks that would make up that index.

Doug Fabian:  That is correct, and I’ll add to that, the price to earnings ratio, many of these companies, these A share companies, is less than 10, and that is the equivalent of buying the S&P 500 in March of 2009, so I just want people to understand that the upside opportunity here—if the global growth story comes online, if we have a global recession—all bets are off.  

But I am still bullish on the US economy, the global economy, and that we’re going to have global recovery, and under that scenario, this fund should perform well.

Steven Halpern:  Now finally, in your successful ETF investing newsletter, you also point to two additional ETFs for investors to consider.  One is the iShares China Large Cap (FXI) and the other is the ProShares Ultra China 50 (XPP). Can you briefly share an overview of these two positions and what you find attractive about them?

Doug Fabian:  Yes I can, Steven.  Let’s talk about FXI, this is the iShares Large Cap China ETF.  This particular exchange traded fund only has about 25 stocks in it.  This is the equivalent of a Dow Jones Industrials for China.  

Now most of the stocks in this particular ETF trade as ADRs in the US.  They’re very liquid.  This is a very large exchange traded fund with over $5 billion dollars invested in it, and it gives you, most of its exposure is to financials.  

Its banks, its insurance companies, that kind of industry.  It’s not as diversified as the China A shares, but it does give you good China exposure, and if my story about China is going to come to fruition, FXI should perform well.  In contrast, the ProShares Ultra, FTSE China 50, this is a leveraged play and I put this into our aggressive growth portfolio.  

Leverage means high risk and—for instance—if FXI goes up 20%, XPP will go up 40%.  It is leveraged twice to the same index that FXI is invested in, so you have to realize XPP has a lot more risk, but again, I’m putting this into our aggressive growth portfolio as a trade.  

I may trade out of this quicker than I do some of the other long-term holdings, but it’s in my newsletter now and we just bought it this past week.  

Steven Halpern:  Just to emphasize for our listeners, as you alluded to, while the ProShares China 50 will go up twice as much as the China large-cap ETF, it also will go down twice as much if the index is declining.

Doug Fabian:  Exactly right, Steven.

Steven Halpern:  Now again, our guest is Doug Fabian, fund expert and editor of Successful ETF Investing.  Thank you so much for taking the time to join us today.

Doug Fabian:  Thanks for having me.

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