Chinese owned companies pulling back from U.S. markets

In years past, Chinese owned companies lined up to sell shares on Wall Street. Now a new trend is surfacing that does not bode well for U.S.-based emerging market investors — but exchange-traded funds may help.

Image courtesy Josh Hallett

China-owned companies are pulling back from markets including the NYSE

Spurred by their government, Chinese owned companies are starting to withdraw from U.S. stock markets, potentially leaving shareholders out in the cold.

Not too long ago Chinese owned companies could raise capital more easily on U.S. exchanges than back home. But the tide has turned, and there’s a wave of Chinese owned companies currently withdrawing from U.S. markets. According to CNBC, Focus Media Holding (FMCN, quote) announced this week it is being delisted and taken private by its chairman and a group of private equity firms. According to the CNBC report, a Chinese state bank has provided $1 billion in loans to help companies with listings abroad move them to domestic exchanges. 

The motive for delisting in the U.S. and listing in China is not entirely innocent. The withdrawals are sometimes attributed to questionable accounting practices and disputes between U.S. and Chinese regulators. It has long been a challenge for U.S. investors and regulators to determine the legitimacy of some of the financial reporting at Chinese owned companies. As China becomes more economically influential, U.S. regulators are demanding higher standards for financial reports.

The cost of complying with U.S. regulatory demands is another reason some cite for the withdrawals from U.S. markets. Some Chinese owned companies blame low share prices, which they contend do not accurately reflect their value. 

What does this mean for emerging market investors? We may have fewer Chinese owned companies to choose from and fewer new stocks to consider. As investors in companies being taken private, shareholders will presumably receive cash for the shares, just as they would in any other buyout. However, many would prefer to continue owning the shares.

The incidence of withdrawal and the possibility of more companies choosing not to list on U.S. exchanges point to the potential advantages of ETF investing. By investing in an exchange-traded fund, the investor eliminates some of the risk associated with buying individual company stocks or ADRs.

With any stocks, investors sometimes choose companies that perform poorly. Perhaps they chose a company from the right country or industry but still lost while that country or industry prospered. Buying an ETF provides the opportunity to be right from a macro perspective — the big picture (country or sector) — while avoiding the worry of picking the wrong company.

For less sophisticated investors, it is always advisable to stick with mutual funds or ETFs. Those new to the markets face a significantly greater risk of choosing the wrong company to invest in. For sophisticated investors, the same risks apply, but if those investors make the right choices, stocks and ADRs can provide substantial returns.

Investing in a mutual fund or ETF eliminates much of the risk that a company may delist or be taken private. Because the typical fund has dozens to hundreds of holdings, a couple of bad ones won’t spoil the overall outcome. Choosing the right country or sector will suffice.

An excellent example of using ETFs to eliminate company risk is the Global X China Consumer ETF (CHIQ, quote). Focus Media Holdings is the 23rd-largest holding of CHIQ, accounting for 2.41% of its portfolio. CHIQ has a total of 44 positions. If we assume the delisting of FMCN is an adverse event for the stock’s shareholders, the owners of CHIQ know they have 43 other positions to rely on.

Buyers of FMCN may have been correct investing in a Chinese consumer company, but they possibly picked the wrong one. CHIQ shareholders have eliminated company risk and are able to benefit from the growth in consumption in China regardless of whatever happens to FMCN.

This new trend also speaks to an underlying concern. If Chinese owned companies believe they are better off going public on Chinese exchanges, how many other companies from other countries will eventually decide to do the same? For U.S. investors, it is already a significant challenge to invest directly on most emerging market country exchanges. If the trend among China-owned companies spreads, it will only make that challenge greater.

As a matter of pragmatism, you may be best served building a primary portfolio composed of ETFs, then adding select stocks and ADRs to the mix. This way the fundamental allocation should stay intact, even if shares of some individual securities do not deliver the anticipated results.

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