Sentiment towards China and Chinese stocks appears to be improving, and analysts see serious potential upside ahead for the iShares China Large-Cap ETF (NYSEARCA:FXI). I’m bullish on this China-focused ETF due to this rising tide of sentiment, analyst optimism, and the inexpensive valuations of the Chinese stocks that FXI holds.
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What is the FXI ETF’s Strategy?
FXI is a $4.9 billion fund from BlackRock’s (NYSE:BLK) iShares with a simple strategy of giving investors “exposure to large companies in China,” according to iShares. The fund gives investors the convenience of “access to 50 of the largest Chinese stocks in a single fund.”
A Turning Tide
China’s President Xi Jinping recently visited the U.S. to meet with political and business leaders, and he received a standing ovation from an audience that included top U.S. CEOs like Apple’s (NASDAQ:AAPL) Tim Cook, BlackRock’s Larry Fink, and Blackstone’s (NYSE:BX) Steve Schwartzman.
Bridgewater founder and billionaire investor Ray Dalio described the dinner as a gathering of “old friends” and felt that the meeting took down the temperature of what had been fairly heated relations between the two superpowers.
Obviously, dinners and standing ovations are more anecdotal than any hard evidence of a real shift taking place, but other factors also indicate that the mood toward Chinese stocks seems to be improving. Case in point, a look through the most recent 13F filings shows that a number of top U.S. investors have been buying shares of China’s largest companies over the past quarter.
Appaloosa’s David Tepper increased his position in PDD (NASDAQ:PDD) (also known as Pinduoduo) by 86.7%, while Tiger Global’s Chase Coleman and RV Capital’s Robert Vinall both initiated positions in the Chinese e-commerce stock during the quarter.
Even the famously skeptical Michael Burry initiated new positions in both Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) through his fund, Scion Asset Management. Burry wasn’t alone in investing in Alibaba, as the aforementioned Coleman and Maverick Capital’s Lee Ainslie also started new positions in the internet and e-commerce giant during the quarter.
Ray Dalio has been bullish on China for quite some time and owns PDD, the iShares MSCI China ETF (NASDAQ:MCHI), and FXI itself. Even Charlie Munger has been a long-time holder of Alibaba through his Daily Journal (NASDAQ:DJCO) portfolio.
Earlier this year, hedge fund manager Ken Griffin said that the “scale and scope of the Chinese equity market is incredibly attractive.”
FXI’s Portfolio
True to its stated strategy, FXI owns 50 stocks, comprising 50 of China’s largest companies, and its top 10 holdings account for 56.7% of the fund.
Below, you’ll find an overview of FXI’s top 10 holdings using TipRanks’ holdings tool.
FXI invests in many of China’s internet giants, with household names like Tencent (OTC:TCEHY), Meituan (OTC:MPNGF), and Alibaba occupying large positions within the fund. However, there’s more to the Chinese economy than just the internet behemoths that get the most attention in the U.S. Companies like electric vehicle maker BYD (OTC:BYDDF) (which Warren Buffett owns a position in) and insurer Ping An Insurance (OTC:PIAIF) also make appearances in the top 10.
Altogether, FXI’s top holdings boast a very strong collection of Smart Scores. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It gives stocks a score from 1 to 10 based on eight market key factors.
A score of 8 or above is equivalent to an Outperform rating. An impressive half of FXI’s top 10 holdings garner a perfect 10 Smart score, including Tencent, Alibaba, Netease (NASDAQ:NTES), Baidu (NASDAQ:BIDU), and BYD, while Ping An Insurance and JD.com also feature outperform-equivalent Smart Scores of 8 and 9 respectively.
Chinese companies also generally trade for cheaper valuations than U.S. companies. For example, FXI looks attractive from a valuation standpoint, with an average price-to-earnings ratio of just 11. This represents a significant discount to the S&P 500 (SPX), which currently sports an average price-to-earnings ratio of 20.2.
Does FXI Pay a Dividend?
In addition to its attractive portfolio of holdings, FXI also pays a decent dividend. The fund currently yields 2.8%. Not only that, but FXI has a proud history as a consistent dividend payer. It has paid dividends to its holders for 16 consecutive years.
Is FXI Stock a Buy, According to Analysts?
Turning to Wall Street, FXI earns a Strong Buy consensus rating based on 41 Buys, nine Holds, and one Sell rating assigned in the past three months. The average FXI stock price target of $37.76 implies 43.6% upside potential.
One Costly Downside
Now, I’d be remiss if I didn’t mention the one downside of FXI — its 0.74% expense ratio. This means that an investor putting $10,000 into FXI would pay $74 in fees over the course of the next year. These fees compound over time and can take a chunk out of investors’ returns. For example, assuming that the expense ratio remains at 0.74% and FXI returns 5% per year going forward, an investor would pay $918 in fees over the course of 10 years.
In fairness to FXI, investing in China is generally an expensive proposition for investors who aren’t based there. Access to the locally-listed shares of Chinese companies can be difficult for investors outside of China.
Furthermore, the other major China ETFs all have fairly high expense ratios as well. For example, the largest China ETF, the iShares MSCI China ETF (NASDAQ:MCHI), has an expense ratio of 0.58%, while the second-largest, the KraneShares CSI China Internet Fund (NYSEARCA:KWEB), charges 0.69%. As you can see, FXI, the third-largest China ETF, is a bit higher than these peers, but it isn’t out of line with them. To an extent, these high fees can be thought of as the cost of doing business in China as a non-Chinese investor.
Looking Ahead
In conclusion, I’m bullish on FXI as a way to gain exposure to China’s biggest and best companies. U.S.-based super investors have been buying shares of companies like Alibaba, PDD, and JD.com, so they seem to sense that a turnaround is in the works, and relations between China and the U.S. seem to be thawing, at least for the moment.
Sell-side analysts seemingly agree, as they are forecasting significant upside of 43%+ for FXI, and it’s hard not to like that type of risk-reward profile. Plus, many of the large-cap Chinese stocks that FXI owns are strikingly cheap, and the fund pays a decent dividend to boot. While FXI is on the expensive side for an ETF, its fees are comparable to other China ETFs.
