CHIQ: Chinese Consumer ETF Is A Contrarian’s Delight (NYSEARCA:CHIQ)

The Global X MSCI China Consumer Discretionary ETF (NYSEARCA:CHIQ) currently has an AUM of $230 million, so it is a relatively undiscovered ETF to invest in mid to large cap consumer discretionary stocks that comprise the MSCI China Index. As such, CHIQ is clearly in the “eye of the storm” when it comes to the global equity market. China has experienced a less-than-stellar economic rebound post Covid-19, and consumer spending seems to be an anomaly amidst the slow recovery.

Furthermore, we cannot think of a part of the global equity markets that is in a bigger and more headline-filled “dog house” than China. And the root cause of investor concerns is the consumer. It seems like the worst place to be looking for an ETF to rate as a buy. Yet that’s what we are doing here.

Why? We believe the uptrend in discretionary spending still has a long runway. As an optimally-priced fund in the space with a bonus dividend component and a history that includes some great comebacks from similar price crashes, CHIQ is the best way we know of to get in early and benefit from this macro upswing.

The CHIQ portfolio sells at 11x forward earnings, but 5-year projected revenue is 19%. That compares to 14x and 10% for the iShares MSCI EAFE Index ETF (EFA). So as non-US value spots go, CHIQ is highly attractive. We are not afraid to take on some risk with a portion of our portfolio. As such, we rate CHIQ a “Buy” on a 3-year time frame.

Chinese consumer may be a bright spot in an otherwise dark macro environment

China’s post-pandemic recovery and battle against deflation has been underwhelming as a whole, but the government has recently instituted stimulus measures to give the economy as jump start. These measures include allowing the People’s Bank of China to hold smaller cash reserves and encouraging banks to lend to qualified developers. China’s actions along with other promising indicators around the world spurred the IMF in January to raise its global growth forecast for 2024.

Currently, the consumer is emerging as the bellwether of a Chinese resurgence. However, the comeback in this sector is nuanced. Any investor making an allocation to the Chinese consumer category must be able to distinguish between what specific sub-sectors are participating in the recovery and which are not.

For example, double-digit growth in traditional retail consumption appears to be over. However, the service sector is indeed experiencing a resurgence. Post-pandemic, Chinese consumers are again excited about traveling and patronizing bars and restaurants. Sales in the footwear and sports and outdoor categories are also trending higher.

Chinese automobile consumption is poised for growth. Announced last July, China’s main economic planning body has created stimuli for increased household vehicle purchases, particularly new energy vehicles (NEV). These measures entail 10 steps including lower costs for vehicle charging, improving power grid capacity in rural areas, promoting NEV use in the public sector, among other themes.

As far as e-commerce, China represents the largest market globally and continues to maintain that status. Chinese culture celebrates and supports the online shopping industry with over two dozen major shopping holidays during the year, the largest one being Singles Day on November 11th. Growth has not slowed and isn’t expected to. See below a chart from 2023 of past and forecasted growth in Chinese e-tail sales.

Smart sector allocation among other attributes

CHIQ’s portfolio construction seems to align well with the specific areas of consumer spending growth outlined above. For example, the first, second and third largest sub-sector allocations are Internet Retail, Motor Vehicles, and Apparel/Footwear respectively. See a chart of the portfolio’s industry exposure below.

We also like the fact that CHIQ pays a dividend. At a yield of 2.5%, it is higher than its category average, though lower than EFA’s 3.0% yield That’s to be expected, given the growth potential of the Chinese consumer, and the nature of the companies that typically populate the CHIQ portfolio. Its turnover ratio is 23% which is for a passively-managed fund.

CHIQ expense ratio is 0.65%, which might seem high to some, but not to us. That’s because expense ratio is of little consequence when we’re talking about an ETF that targets a micro niche of the global equity market, and in a given year can gain or lose 30% or more. Thus, we don’t put a lot of weight in the expense ratio, and believe other metrics are more determinant of an ETF’s quality.

Here’s what we mean, CHIQ is down 29% the past 6 months. Shocker? Not at all. Similar declines have occurred 5 times in the past 12 years, as shown below. Temporary drops of this magnitude, for a variety of reasons, are part of the process when investing in Chinese stocks. That’s why, despite the tremendous size of its economy, China is still considered an “emerging” market. The future potential of the Chinese consumer represents the clearest path to moving beyond emerging to emerged, but there’s plenty of risk to go with that potential reward.

CHIQ trades at a very appealing long-term entry point on a technical basis. Its current price represents a 11.5% discount to its 200-day MA. See the chart below.

All foreign investments come with risks

As with any investment in a non-U.S. market, currency risk is always a factor. As CHIQ is not currency-hedged if the Chinese yuan were to fall in value against the dollar, U.S. investors are not protected from losses incurred through foreign exchange.

China itself presents a risk. It’s no secret that there exist geopolitical tensions between China and many parts of the world, including the U.S. If those tensions were to progress to something more serious, any investment in China is at risk.

Another issue specific to China is the country’s slowdown in population growth. In 2022, China’s population declined for the first time in six decades and its total fertility rate dropped to a record low of 1.1 in 2022 from 1.3 in 2020. Growing demand for consumer products is dependent on a growing population.

CHIQ is not highly diversified, but that’s not an issue for us, since this type of ETF is likely to be a smaller portion of a bigger portfolio. Eight stocks make up 50% of the 81-stock portfolio, but in a micro area of the global market like this, there’s a better chance that the larger portfolio will follow the leaders.

As mentioned above, it is overweight to certain sub-sectors, which is inherent for a fund that strategically tilts towards areas that appear to show the most potential for growth. However, if those bets are wrong, the fund’s overall returns can be driven by relatively large allocations to poorly-performing industries. That is how CHIQ became more investable, as some of its biggest holdings cratered in value recently.

Conclusion

There are many ETFs betting on the success of specific sectors in a Chinese resurgence. Private discretionary consumption appears to be leading the cause right now, but not on a wholesale level.

This story might take some time, but the plight of the Chinese consumer and the China ETF space in general seem more like a classic “overshoot” to the downside to us, rather than a condition that will last for years. With CHIQ trading at a deep discount to potential future earnings growth and the ETF’s price already “broken,” we think this is a good long-term entry point. The revival of the Chinese economy is more a “when” than an “if” in our view. We rate it a Buy on a 3 time frame.