FXI: China Opportunity, or Too Many Unknowns?

Investors would expect to navigate a ‘geopolitical hornet’s nest of risk.’

The iShares China Large-Cap ETF (FXI) holds leading Chinese companies that trade on the Hong Kong stock exchange and are available to international investors. A top holding is Chinese e-commerce giant Alibaba Group Holding.  

Investors are scouring the world for opportunities in a year when the U.S. stock market has been under significant selling pressure. Since China is the world’s second-leading economy, FXI is on many investors’ radars, but Chinese stocks have done even worse than the leading U.S. stock market indices in 2022.  

At face value, FXI offers an opportunity, but it comes with a geopolitical hornet’s nest of risk that has caused the ETF to underperform the most diversified U.S. stock market index this year.  

FXI Down vs. S&P 500 

FXI holds an impressive, diversified portfolio of Chinese stocks: 

Source: ETF.com 

At $23.90 per share on Nov. 7, 2021, FXI had $3.88 billion in assets under management and traded an average of just over 35.6 million shares daily. The ETF charges a 0.74% expense ratio.  

FXI is a highly liquid ETF for those seeking exposure to the Chinese stock market.  

2022 has been an ugly year for equity investors:

Source: Barchart 

The above chart shows the most diversified U.S. equity index ETF product, the SPDR S&P 500 ETF Trust (SPY), has declined 20.6%, falling from $474.96 on Dec. 31, 2021, to $377.05 on Nov. 7, 2022.  

FXI has done even worse:

Source: Barchart 

Over the same period, FXI fell from $36.58 to $23.93 per share or 35%. SPY reached a record peak in January 2022, while FXI’s all-time high was back in October 2007.  

Recovery From Lows 

The long-term chart highlights that FXI’s most recent low was $20.87 in October 2022. The shares have recovered over the past weeks but remain in a bearish trend as worldwide investors have avoided Chinese investments for three compelling reasons: 

• COVID-19 lockdowns have weighed on China’s economy and earnings for its companies. 

• Ties with Russia have caused many investors to shy away from China.  

• The trend in Chinese stocks has been lower since February 2021. Moreover, it has been a decade and a half since Chinese stocks peaked, while U.S. stocks reached the last record high in January 2022.  

While Chinese stocks and FXI have recovered from last month’s low, they continue to underperform U.S. stocks.  

The Case for FXI 

Value investor Warren Buffett once said, “Price is what you pay; value is what you get.” Buffett and his partner Charlie Munger have achieved success by purchasing stocks below their intrinsic value. In his latest Q2 2022 13 F filing, Chinese e-commerce giant Alibaba was Munger’s third-leading holding, representing 14.68% of his portfolio. Munger has lost millions on his Alibaba shares, but it remained a core portfolio investment.  

Despite falling prices and a host of political concerns, a solid case can be made for being in Chinese stocks: 

• China is the world’s second-leading economy, challenging the U.S. for a leadership role.  

• Centrally planned, China does not plan its economic growth on a quarter-to-quarter basis. Instead, it has a long-term, multiyear approach.  

• From a short-term perspective, China is emerging from its zero-COVID-19 protocols, which could boost Chinese stocks, leading to an investment boom.  

• China has invested worldwide to secure raw materials, influence economies and build strategic relationships that benefit its economy and business interests.  

• China is the world’s most populous country, with a stable political system. President Xi was recently appointed the leader for life at the October 2022 Chinese Congress.  

When it comes to value, FXI has a 10.03 price/earnings ratio, a price/book ratio of 1.08 and pays a 1.46% dividend. SPY’s price/earnings ratio is 17.24, the price/book ratio is 3.52 and it pays a 1.75% dividend. Aside from dividend yields, FXI offers a compelling value compared with SPY.  

Risk: The Price for Rewards 

Geopolitical risk is the 800 pound gorilla for FXI. China’s “no limits” alliance with Russia, warm relations with missile-firing North Korea and support for Iran are all investment roadblocks that have weighed on FXI and Chinese shares.  

Moreover, deteriorating relations with the U.S. and Europe over China’s “reunification” plans with Taiwan have caused many investors to bypass and shun Chinese equity investments.  

While China and FXI present a compelling value case, the risk is always the price for potential rewards. Markets reflect economic and geopolitical landscapes.  

While China passes the financial and value tests, the geopolitical environment remains a big warning sign. FXI is a contrarian investment with a boom potential but a bust history over the past years.