China, the world’s second-largest economy, is catching up to the U.S. While estimates might differ, China is expected to become the largest economy globally sometime this century. Investing in international stocks is a good diversification strategy. How can you invest in Chinese stocks? There are many ways to invest and trade in Chinese companies.
There's always the lure of investing in an emerging market like China, which is growing at over twice the U.S. economy's growth. However, facts over the last decade portray a different picture.
U.S. stocks outperformed Chinese stocks in 2020 and have done so consistently over the last decade. Also, despite its economy growing at a fast pace, Chinese stocks have underperformed most global markets over the last decade. The Shanghai Composite Index is still trading below its 2007 highs, as can be seen in the graph above.
Why Chinese stocks are appealing
China is the world’s second-largest economy and it's among the fastest-growing economies. Several Chinese companies like Huawei and Alibaba have grown into strong global brands. Also, through Chinese stocks, U.S. investors can bet on the domestic consumption story in China. In some areas, especially fintech and electric vehicles, China offers better opportunities than the U.S. market.
How to invest in Chinese stocks
There are many ways to invest in Chinese stocks, including:
- Buy ADR (American depositary receipts) issued by Chinese companies
- Buy Chinese stocks that trade in OTC markets
- Buy China or Hong Kong-listed Chinese companies
- Buy GDR (Global depositary receipts) issued by Chinese companies
- Buy ETFs and mutual funds that invest in Chinese stocks
All of these avenues have their unique risk-return tradeoffs.
The easiest way to invest in Chinese stocks would be to buy the companies that have issued ADRs in the U.S. This would include companies like Alibaba, NIO, Baidu, and XPeng. There are companies like Tencent that aren't listed on the U.S. markets but you can trade in them on the OTC markets.
Some Chinese companies like China Pacific Insurance have also issued GDRs that trade on the London Stock Exchange. If you want to get a bit more adventurous, you can buy Chinese stocks that trade on the Hong Kong and Shanghai Index.
It's worth noting that not many Chinese companies, especially those that aren't global brands and focused on the domestic economy, trade on global markets. Instead, they trade in Chinese stock exchanges. Many brokers in the U.S. let you buy Chinese stocks that trade on Hong Kong and Chinese stock exchanges.
Meanwhile, if you are looking at diversified exposure to the Chinese stock markets, the best way would be to look for mutual funds and ETFs that invest in Chinese stocks. If you prefer a low-cost passive exposure to Chinese stocks, you can choose from ETFs that invest in Chinese stocks.
Top Chinese stocks for investors
If you want to invest in Chinese stocks, Alibaba looks like a good value stock to buy. Its valuations look reasonable at these levels. The stock’s valuation discount versus Amazon has widened, which you can see in the graph above. Alibaba might see a valuation rerating in the near term. In the electric vehicle ecosystem, NIO, XPeng, and Li Auto look like good bets.
Chinese stocks come with certain risks
It's always riskier to invest in foreign companies than investing in domestic stocks. There are currency risks, political risks, and legal risks when investing in any foreign company. As the Luckin Coffee accounting scandal in 2020 showed, U.S. regulators have their hands tied when probing foreign companies.
The risk of investing in Chinese stocks has increased over the last two years. U.S.-China relations have soured and aren't expected to recover much even under the Biden administration. Secondly, there's a global backlash against China over its handling of the COVID-19 pandemic in the initial days.
Finally, the risk of investing in China has increased under President Xi Jinping. Under his watch, the communist government clamped down on Ant Financial’s IPO, which could have become the world’s biggest IPO after Alibaba. Alibaba co-founder Jack Ma wasn't seen in public for months after he criticized the country’s regulators.
Outlook for Chinese stocks
The outlook for Chinese stocks is positive, especially for companies that are focused on the domestic economy. China is transitioning from an investment-led to a consumption-led economy, which would benefit the companies that are focused on the domestic growth story.