Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today at the ETF Invest Conference with Kevin Carter. He's the CEO of BaoCap. We're going to talk about China's growth trajectory and how U.S. investors should think about investing in the country.
Kevin, thanks for joining me today.
Kevin Carter: Sure, thanks for having me.
Glaser: There has certainly been a lot of talk about if China's going to have a hard landing or a soft landing. You kind of reject that lens. Why do you think about China's growth a little bit differently?
Carter: I don't think there's a landing involved in a country's growth curve. I mean I think that when people talk about a hard landing, I think what they're talking about is whether China is going to fall apart, or if there are going to be terrible economic calamities. The fact is China is slow. Everyone knows China is slowing. China's been slowing for the better part of a year, and that's going to continue. It's going to slow down because of the law of large numbers, and it's also slowing down because the places that have been China's biggest consumers of China's goods--Europe and the United States--those economics have slowed down. So, China's clearly slowing, but the analogy of a hard or soft landing, I just don't think it really fits the situation.
Glaser: So, what kind of policy tools does China then have to kind of make that slowdown not become that landing? How do they really keep that from happening?
Carter: Well, first of all, I think it's important to understand that the Chinese government has done a number of things to slow down the economy themselves. So, for the last almost three years it's been Chinese policy to try to stop the growth in home prices and in fact bring home prices down. This is not a stance that they've softened on even with the rest of the global economy slowing down. So, I think it's important to understand that China has had their foot on the brake and just letting go of the break in some ways would be some sort of stimulus.
China also has a lot of reserves, and I know there's a lot of debate about whether or not they have too much infrastructure already. Are they building bridges and roads to nowhere? But the fact is they do have a lot of money in the bank, and they can stimulate through infrastructure-types of projects, which I think the middle and west regions of the country certainly still need. And then there are other things they can do around the edges to help with consumption--lowering taxes and so forth.Read Full Transcript
Glaser: How about the upcoming leadership change? Do you see that having an impact on the economy, or will it be a smooth transition?
Carter: Well, it's certainly been an interesting year in terms of the leadership change, and I know there are a lot of people that believe that the government won't do anything dramatic until the new regime has taken office early next year. I don't think you'll see anything significant in terms of a change of course. The Chinese Government very much works by consensus. They plan well ahead of time. The change that's happening was first put in place many years ago. So, I don't think you'll see any dramatic change of course, though I think most observers think that the new leadership will be a little bit more reform-minded and take some actions to help reform parts of the economy that perhaps haven't evolved as much as they'd like.
Glaser: Shifting gears a bit into how investors, particularly U.S.-based investors look at China. What are some of the biggest mistakes people make when choosing how much money to maybe allocate to China or actually investing and those sorts of things?
Carter: I think our position is that investors in the U.S. are systematically underexposed to China. If you just look at China's economic footprint, if you will, to borrow a term from Rob Arnott, China is 12% to 14% of global gross domestic product. China has 20%-plus of the world's population. Yet if you look at U.S. institutional investors and advisors as well, you find that they typically have 1.5% maybe 2.0% in China, and that strikes us as being really underweight. I mean this is a country that's contributing 35% of global GDP growth. Why on earth would you want to have only 1% or 2% exposure to China's growth?
The second problem is the tools, the vehicles that advisors and investors are using, we think, are somewhat flawed. If you use the leading China ETF, you get a portfolio that's very narrow and heavily concentrated in state-owned banks, state-owned oil companies. Those two sectors represent about 75% of that fund's assets. You get no consumer exposure. The largest China fund has no consumer holdings; it has no technology holdings. And those are really the growth drivers of China. And I think that's one of the problems with trying to index China. So, we've tried to make indexes that are more diversified and give you a broader set of exposures to growth sectors like the ones I just described.
Glaser: Does it make sense for investors then to look at companies domiciled in China, one's listed in New York, and maybe companies in the U.S. that are exposed a lot to China? You have all those different options. Are some better than others, or is it really a matter of holding the whole basket?
Carter: Well, we believe in diversification. So, we have our flagship strategy, if you will, that does all of the above. We own Chinese stocks in Hong Kong and New York. We own Hong Kong real estate developers; that's another one of the sort of quirks in the world of indexing. Hong Kong is a developed country, that's owned by China, an emerging country. So if you want to play China real estate, and you're not worried about all [hedge fund manager] Jim Chanos' arguments, the best way to do that is through the Hong Kong developers. And then finally, you can get a very good exposure to China through non-Chinese companies that are benefiting from Chinese demand for commodities and other natural resources, demand for industrial goods, and demand for consumer goods, including particularly luxury items.
So Yum Brands based in Kentucky is probably one of the best ways to invest in China. There's a well-known story of the company's success there. So, there are lots of ways to get your exposure to China. I think in general, we prefer diversified ways, and we also favor doing what you can to lower the weights in the state-owned enterprises and state-dominated sectors, and increase the weights in consumer and technology types of names.
Glaser: Well, Kevin, thanks so much for your thoughts on China.
Carter: Thanks very much.
Glaser: For Morningstar, I'm Jeremy Glaser.