The ETF benefitting from China’s communication services growth

The Global X MSCI China Communication Services ETF fell last week as banks cut their outlooks for the country’s economic growth. However, the fund’s top holdings, including tech giants Baidu and Tencent, appear to be experiencing strong growth in 2023, and the fund is up 8% overall.

  • Global X MSCI China Communication Services ETF fell 6.8% last week amid revisions for China’s GDP growth, but is up 8.1% year-to-date.
  • Top holding Baidu tipped to rise off generative AI boom, and is up more than a fifth year-to-date.
  • Outlook positive for key holdings including Baidu, NetEase and Tencent.

The Global X MSCI China Communication Services ETF [CHIC] tumbled 6.8% in the week to the close last Friday.

China recently saw several banks revise their gross domestic product (GDP) outlooks for 2023. Goldman Sachs was the latest, slashing their outlook from 6% to 5.4%, following downward revisions from UBS, Bank of America and JPMorgan.

Then last Friday markets in Hong Kong slipped by 1.6% on the back of core inflation figures coming out of Japan at 3.2% for May, above the Bank of Japan’s 2% target.

However, the fund is up 8.1% year-to-date, as China recovers from pandemic restrictions and regulatory crackdowns.

As its name suggests, the CHIC ETF offers exposure to companies within China’s communications services industry, specifically those contained within the MSCI China Index.

As of 31 May, the fund’s top industries are internet software and services, which account for 46.3% of the fund’s exposure. This is followed by packaged software (10.8%), auto parts (7.2%) and information technology services (7%), with other sectors making up the remainder of the fund’s exposure.

AI to drive Baidu’s gains

The top holding in the Global X MSCI China Communication Services ETF as of 23 June is Chinese tech giant Baidu [9888.HK], with a sizeable 10.04% share.

Last week Baidu stock was upgraded by Morgan Stanley analyst Gary Yu to an ‘overweight’ rating from ‘equal weight’, with the search engine operator tipped to rise on the back of the artificial intelligence (AI) boom. Yu said Baidu was “the most obvious beneficiary” of China’s move towards adopting the technology.

In May, Baidu released its first quarter (Q1) 2023 earnings, with non-GAAP operating margins jumping 23% year-over-year. Rong Luo, Baidu chief financial officer, also said that generative AI would drive the company, saying it “will continue to invest unwaveringly in this area”. Around 200,000 accounts have reportedly signed up for the Ernie bot, Baidu’s rival to ChatGPT.

Second-largest holding NetEase [9999.HK], with a 9.26% weighting, posted positive earnings in May. Its revenues rose 6.3% year-over-year for Q1, beating analyst forecasts.

The third-biggest holding in the CHIC fund is Chinese tech and games firm Tencent [0700.HK] with an 8.70% weighting. In May, Tencent announced an earnings miss, but posted its fastest revenue growth in a year, following a prolonged slump due to Covid and a months-long regulatory freeze on licences for new games in China.

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Positive outlook for key CHIC holdings

China’s tech companies, many of which fall within communications services in the CHIC ETF’s holdings, have had a tough couple of years, thanks to coronavirus restrictions, Beijing’s regulatory tech crackdown and simmering geopolitical tensions with the US. This year, foreign investors have been offloading these shares, the Financial Times reported earlier in June. According to S&P Capital IQ data, the country’s tech firms have lost $300bn in market value since the beginning of the Covid-19 pandemic.

Last year, JPMorgan even said Chinese internet shares were “uninvestable”, though it later withdrew this statement.

However, despite a shaky outlook for the wider economy, the Global X MSCI China Communication Services ETF’s overall growth this year suggests the tide may be turning for the companies in its portfolio.

Baidu is up 22.7% year-to-date, though down 3.8% in the past week. NetEase is up 27.3% year-to-date, but down 5.3% in the past week. Tencent is up 5.7% year-to-date, but down 6.8% in the past week.

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