How to Invest in the Shanghai Composite Index from Outside of China

Updated January 9, 2021

How can you invest in the Shanghai Composite Index from Outside of China?

That will the topic of this article after speaking about how to invest in the FTSE and the Nasdaq in recent articles.

It is our viewpoint that the Chinese markets are riskier than the US and other developed markets, but can be held safely in a diversified portfolio.

If you are looking to invest you can contact me, use the WhatsApp function below, or email me (advice@adamfayed.com).

Introduction

An index fund is a type of mutual fund or exchange-traded fund (ETF) that contains all (or a representative sample) of the securities in a given index in order to closely compare the performance of that benchmark.

There are indices – and index funds – for almost every market and investment strategy you can think of. You can buy index funds through your brokerage account or directly from an index fund provider.

When you buy an index fund, you get a diverse selection of securities in one simple, inexpensive investment. Some index funds provide access to thousands of securities in a single fund, helping to reduce overall risk through broad diversification.

By investing in multiple index funds that track different indices, you can create a portfolio that matches your desired asset allocation. For example, you might invest 60% of your money in indexed equity funds and 40% in indexed bond funds.

Index mutual funds are admired by everyone, and for good reason: they are easy, convenient, diversified and inexpensive way to invest in the stock market.

In short, an index fund is an investment that tracks a market index, usually made up of stocks or bonds.

Index funds usually invest in all of the components that are included in the index they track, and they have fund managers who are tasked with making sure that the index fund performs in the same way as the index. And today we are going to talk about one of the most powerful index fund trading platforms of China. 

If not the first, China is the second largest economy in the world, depending on how you measure it, with a nominal GDP of nearly $ 12 trillion in 2017 growing at about seven percent. Given the country’s growing influence, international investors are showing an increasing interest in its stock markets.

In fact, many of the world’s largest IPOs have been raised through its markets, including the $ 22.1 billion IPO of Agricultural Bank of China in 2010.

In world history, no economy has made such a big leap in such a short time as China in the last generation, although China still remains underdeveloped compared to Japan, South Korea and Taiwan.

A country of more than 1 billion people, which not so long ago relied on a bicycle as its primary means of transportation, is today the largest car market in the world.

It is also the world’s largest smartphone market and is set to overtake the United States as the largest retail market in 2019. Today, China is the second largest economy in the world after the United States.

According to HSBC, by 2030 China will overtake the United States and become the number one economy in terms of gross domestic product.

The Global Bank also expects it to be the largest contributor to global economic growth through 2030, following the 2008-09 financial crises.

Given China’s size and GDP growth rate of 6.6% in 2018, it should come as no surprise that so many investors are interested in Chinese equities.

In this in-depth review of Chinese stocks, we’ll look at the benefits and risks of entering the Chinese market, how to analyze Chinese stocks, the options that investors in China have, and finally the best Chinese stocks to buy. So first of all let’s figure out what the Shanghai Composite Index is and after see the process of investing in it.

There are many risks associated with investing in China, including that the aforementioned stats are lies from a one party state.

There has already been a lot of speculation that China’s growth rates are much lower than the official reported number.

What is the SSE Composite?

SSE Composite, short for Shanghai Stock Exchange Composite Index, is similar to NYSE Composite or NASDAQ Composite in the United States.

The index is designed to display the overall performance of the stock market at any given time, with a base value of 100 issued on December 19, 1990. The index includes all stocks – both A and B – that are listed on Shanghai Stock Exchange weighted by market capitalization.

For international investors, the Shanghai Composite makes it easy to gauge the health of the Chinese stock market that can be difficult to obtain elsewhere.

Most investors are forced to trade Exchange Traded Funds (“ETFs”) or American Depositary Receipts (“ADRs”), which rarely include all of China’s large publicly traded companies. This means that the SSE Composite Index and associated indexes may be the best way to measure overall performance rather than ADR performance.

Other SSE Indexes

The Shanghai Composite Index may be the most quoted index in the Chinese stock market, but SSE also provides three other indices for investors, including SSE 50, SSE 180, and SSE 380.

Simply put, these indices track the 50, 180 and 380 largest members of the Shanghai Composite Index much like the S&P 500 tracks the 500 largest US stocks. But it’s worth noting that many of China’s largest companies are state-owned or heavily regulated.

In addition to these popular options, SSE also offers investors a range of market cap, asset class or industry classifications. These options range from the SSE Consumer Staples Sector Index to the SSE 180 Value Index and the SSE Corporate Bond 30 Index, offering investors a wide range of opportunities to explore the economy. For example, investors can look at the consumer goods index to see how consumer goods companies are performing.

How to invest in Shanghai Composite Index?

International investors looking to invest in the Shanghai Composite Index have many options at first glance, but few of them can truly mimic its results.

While there are many different Chinese ETFs available in the US, it has become commonplace for them to have significant discrepancies with the actual Shanghai Composite Index.

This is because the Shanghai Composite Index tracks “A” stocks, which are only available to local investors and not international funds.

Since this market has less liquidity and significant weighting against smaller companies, its performance can be very different from popular Chinese ETFs such as the iShares FTSE / Xinhua China 25 Index (FXI), which invest in H stocks.

However, investors simply looking to enter the Chinese market have many options, including:

• iShares FTSE / Xinhua China 25 Index ETF (FXI)
• Claymore / AlphaShares China Small Cap ETF (HAO)
• iShares MSCI China Index Fund (MCHI)

International investors should keep in mind that there are many unique risk factors for investing in China compared to local US companies.

For example, the Chinese government is playing a much more active role in regulating companies within its borders, which increases the level of political risk. There may also be currency risks associated with the actions of the central bank to control the valuation of the Yuan.

More about investing in SSE

Mainland China, supported by a huge trade surplus and new economic freedoms, is allegedly growing at a fast pace.

However, since the Shanghai Stock Exchange is closed to direct investment by foreign individuals, the only way to invest in the market is through Chinese stocks or funds traded in the United States, as well as through US institutional investment companies.

Do a little research on China’s economy and companies listed on the Shanghai Stock Exchange.

The exchange publishes its major indices as SSE 180 and SSE 50, representing the largest public companies available for trading. Instead of a literal ticker, Shanghai identifies companies with a six-digit code; Shanghai Pudong Development Bank, for example, is listed as 600,000.

Many of China’s largest companies also trade on US exchanges; Financial company Noah Holdings Limited is listed under NOAH on the New York Stock Exchange.

Open a brokerage account and start trading Chinese stocks or US-listed ETFs to gain insight into the Shanghai and Shenzhen stock markets.

ETFs contain a basket of Chinese stocks and rise or fall in line with the general direction of the Shanghai Stock Exchange. Individual stocks traded in the US will fluctuate based on investor demand, company reports, and economic statistics released by the Chinese government.

Trade index funds that match the performance of the Shanghai Market Index.

The SSE 180 Index Fund matches the composite index, buying new shares when SSE 180 adds a new security and selling them when the company is removed from the index.

The fund also pays dividends on the shares it owns. The China Region Fund is an open-ended mutual fund that invests in companies based in China or companies in Asia that do most of their business with China.

About ETFs

Best Shanghai Composite ETF

One of the most popular ways to invest in Chinese stocks is the ETF Deutsche Xtrackers Harvest CSI 300 China A-Shares Exchange (ASHR). This fund allows US investors to invest in Chinese Class A shares listed on the Shenzhen and Shanghai stock exchanges through partnerships with Deutsche Bank and Harvest Global.

ASHR is down nearly 10% this year and includes stocks from a variety of sectors, but is more focused on the financial services industry. Its holdings account for about 31.16% in financial services, 13.39% in consumer goods, 11.49% in industry, 10.4% in technology and 8.84% at the discretion of consumers.

Largest ETF assets include Ping An Insurance, China Minsheng Banking Corp. Ltd, Kweichow Moutai Co. Ltd., Industrial Bank Co., Ltd., China Mingsheng Banking Corp. Ltd., China Vanke Co., Bank of Communications Co., and Jiangsu Hengrui Medicine CA.

Other options for Chinese ETFs

While the Harvest CSI 300 China-A Shares Exchange is probably the most direct way to track Shanghai-listed stocks, a host of other ETFs can help investors track the advance of Chinese stocks.

These include the VanEck Vectors ChinaAMC CSI 300 (PEK) ETFs, the KraneShares Bosera MSCI China A ETFs (KBA), and the COSP FTSE China A50 ETFs (AFTY).

The VanEck Vectors ChinaAMC CSI 300 ETF follows the CSI 300, which includes the 300 largest stocks in the China A-class stock market.This fund fell about 13% in 2020.

The KraneShares Bosera MSCI China ETF is down more than 5% YTD. It tracks the international MSCI China A index, which follows the high and mid-cap Chinese stocks on the Shenzhen and Shanghai stock exchanges.

Finally, the CSOP FTSE China A50 ETF tracks 50 large-cap companies in 10 sectors. This year it has dropped by almost 10%.

If you are looking to invest in the Shanghai Composite Index with access to Chinese A-Share, consider the Harvest CSI 300 China-A Shares Exchange option first. But other ETFs offer the opportunity to invest in China’s rapidly growing economy as its markets slowly open up to foreign investment.

Why you should invest in China stocks?

There is one argument that the Chinese Stock Market is very undervalued after falling over the last 14 years.

If we compare the returns to the US Stock Market over the same period, we can notice a huge difference:

There is another argument which centres around economic growth.

Namely, globalization has turned China into a world factory, a manufacturing hub for industries ranging from electronics to clothing and toys, and the gradual liberalization of China’s communist government has allowed the economy to harness the forces of capitalism, including foreign investment and consumer choice.

The combination of these two forces, along with technologies such as the Internet and mobile computing, has led to a flourishing middle class in China.

As the Chinese population moves from the countryside to the cities, they are adopting the trappings of modern life.

Beyond manufacturing, China is now emerging as a consumer-driven economy as retail sales grew 9% to $ 5.6 trillion last year and Chinese companies are reaping the benefits of a fast-growing economy.

As the Chinese government continues to invest in infrastructure and stimulate the economy, and many Chinese people move to new lower-tier cities (which China calls its smaller cities) in the coming years, China and China stocks should continue to overextend.

These arguments, however, assume that GDP growth and stocks are connected. They aren’t.

So, the third argument, which is around diversification, is a stronger one to make.

Why not add 10% into emerging markets and China, given the low valuations?

How to Analyze China Stocks before Investing

Most investors shouldn’t buy individual stocks. It is better to track the market.

However, if you really want to buy individual names, you need to look out for a few things.

When looking for individual Chinese stocks, investors will want to use many of the same tools and metrics as for any other company to gauge potential stock purchases. These include the following:

• Revenue growth is always a key indicator of a stock’s potential, but this is especially important in the case of Chinese equities, as investors will want to rely on high revenue growth of 20% or more, which shows that the company is taking advantage of China’s excessive economic growth and capitalizing on the huge accessible market for China’s fast-growing middle class, which now numbers around 400 million.
• Competitive advantage also deserves investor attention, as competitive advantage is especially important in fast-growing markets, as assets such as well-known brand or network effects can lead to high returns in the future for high-value and sometimes unprofitable growth stocks.
• Relationships with other companies are also a unique aspect of Chinese equities, and investors should pay attention to this. For example, tech giants Alibaba and Tencent own stakes or have relationships with many smaller companies including Baozun, Uxin, and JD.com. Given the interconnectedness of many Chinese companies, such relationships are one source of competitive advantage, and investors should look for companies that do.
• Public and private companies and the differences between them. The most unique feature of China’s economy is its commitment to “state capitalism,” whereby the government owns many enterprises, especially in strategic industries such as banking, telecommunications, aviation and energy, but the economy continues to operate according to market principles. Many of China’s largest corporations are state-owned, and these stocks tend to pay dividends more slowly in more traditional industries. Investors looking for fast-growing stocks in China will want to focus primarily on tech companies, which are more dynamic and innovative and tend to be privately owned. Because of this difference, Chinese tech stocks tend to attract the vast majority of investors to China.

Investing in Index Funds: What you need to know

The most obvious advantage of index funds is that they consistently outperform other types of funds in terms of overall performance.

One of the main reasons is that they usually have much lower management fees than other funds because they are passively managed. Rather than having a manager actively trading and a research team analyzing securities and making recommendations, an index fund portfolio simply duplicates the portfolio of a designated index.

Index funds hold investments until the index itself changes (which do not happen very often), so they also have lower transaction costs. These lower costs can make a big difference to your bottom line, especially in the long run.

What’s more, by trading securities less frequently than actively managed funds, ETFs generate less taxable income that must be passed on to their shareholders.

Index funds have another tax advantage. Since they buy new lots of securities in the index every time investors put money into the fund, they may have hundreds or thousands of lots to choose from when selling a particular security. This means that they can sell lots with the least capital gains and therefore the lowest tax rate.

5 tips for better index investing

Building a basic index portfolio is not difficult. Here are five tips for doing this.

Start with a classic three-fund portfolio. It is a portfolio of two stock funds and one bond fund. The share allocated in a portfolio for equities can be broken down into two parts: 2/3 for the US broad market index fund and 1/3 for the broad foreign equity market index fund. The share allocated in the portfolio for bonds can be fully placed in the bond index of the broad US market. Cash is not included in the investment portfolio, so it is not included here.

Choose simple index funds. This is the lowest cost index follower option on the market. Asset management company Vanguard has mutual funds and ETFs for specified asset classes.

Choose related funds judiciously. Companion funds (or “satellite funds”) are optional additions to a portfolio of three funds. They are like the icing on the cake. Such funds can be real estate index funds (REITs), small-cap value equity funds, and inflation-protected bond funds. But if you don’t like frosting and just want to stick to the basics, this is a good option too.

Don’t overdo it with diversification. A little frosting adds flavor to the cake, but too much frosting can be bad for your stomach. Adding too many assets to a portfolio increases its costs and begins to diminish returns. For example, in one of my articles, I discuss the pointlessness of dividing a portfolio of US stocks into equal proportions between growth stocks and value stocks. This brings nothing, but increases costs.

Stay on course. This is one of John Bogle’s famous sayings. The founder of Vanguard explains over and over that the best investment results come to those who keep their costs low and do not panic in the face of danger. When times are tough, then, according to another famous phrase from Bogle: “Don’t do anything, just stay where you are.” Have faith and reap the benefits.

Index investing has gained popularity among the general public over the years, while Wall Street has fought the idea. Then the market wizards figured out how to make money on it. They took this simple idea (index investing), made it more complex, and added commissions to it. Many index fund and ETF strategies in today’s market involve leveraging and active management such as market timing. These strategies are not in your best interest. They are designed to get money from you, not for you.

True index investing is efficient and cost effective. It allows you to get the market yield minus a small commission. When properly designed, an index fund portfolio is the most likely to meet your long-term investment goals.

So index fund investment is a very profitable deal, especially for novice investors. There are plenty of benefits in investing in Shanghai Stock Exchange Index, starting from low taxes and finishing with higher incomes.