Chinese Stocks from a Factor Lens

Seeking greener pastures for quant strategies

August 2021. Reading Time: 10 Minutes. Author: Bill Yeskel, CFA

SUMMARY

• Foreign stock ownership is low in China and the market is dominated by retail investors
• This provides an opportunity for investors to deploy quant strategies
• Factor investing has been far more attractive in Chinese than U.S. equities in recent years

INTRODUCTION

The latest chapter in the complicated relationship between international investors and Chinese equities has interesting elements that bear some thought and analysis. First, we will talk about the current events briefly, then we will review the recent and not so recent factor performance there, and we will finish this note with a few thoughts about the future.

WHAT HAS HAPPENED RECENTLY?

Eye-catching headlines like Cathie Wood selling Chinese stocks in July 2021 as a response to Beijing’s widespread clampdown on sectors ranging from education to technology wiped out about $1 trillion of value in shares listed on the mainland, Hong Kong, and the US. For perspective, the ARK Innovation ETF reduced its Chinese holdings from 8% of its $23 billion in AUM to less than 0.2% as of the writing of this note.

The main reason behind the bearish outlook for Chinese equities is the new policy cracking down on many Chinese companies, many of them in the technology sector. Analysts speculate that Chinese leadership has been keener to make politically motivated decisions given the economic rebound earlier this year. Also, political tensions, which have remained high with the Biden administration, have provided further justification to China’s focus on security and self-sufficiency.

Against this backdrop, President Xi is moving assertively to address social, economic, and national-security priorities that in many cases have lingered unattended for years. With these elements in mind, many of the regulatory actions enacted recently have been targeting U.S.-listed companies, which explains the recently widening performance gap between onshore and offshore Chinese stocks.

FACTOR PERFORMANCE IN CHINA

Before we analyze the factor drivers behind the performance of Chinese stocks, let’s take a moment to remind ourselves of the drivers for the demand for onshore Chinese stocks in a portfolio. First, China has the second larg