Exploring the Performance of Chinese ADRs–Watch out Below!

Exploring the Performance of Chinese ADRs–Watch out Below!

November 24, 2014 Uncategorized
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(Last Updated On: November 24, 2014)

Due to the recent IPO craze associated with ALIBABA, we received increased interest from investors wanting to learn more about Chinese stocks. To get a sense for Chinese ADR performance we conducted a high level analysis on Chinese ADRs.

Data Description

Backtested period: 07-01-1995 to 12-31-2013.

Universe: We screen Chinese ADRs in Bloomberg and collect their CUSIPs as the identifier. For missing CUSIPs, we manually update them by searching the internet. As of September 31st, there are 275 Chinese ADRs. We use this list as the starting universe, but should note we could not identify all the Chinese ADRs in our databases.

Portfolio construction: We construct the portfolio on July 1st every year, and buy & hold until June 30th the next year.

Returns are gross of all fees and represent total returns to include dividends and distributions.

Legend

  • CHN_ADR_VW: Annual buy & hold value-weighted Chinese ADR returns.
  • CHN_ADR_EW: Annual buy & hold equal-weighted Chinese ADR returns.
  • Shanghai Index: Shanghai Exchange Composite Index.
  • SP500: SP500 Total Return Index.

Below is the descriptive statistics on Chinese ADRs which we have identified.

Descriptive Statistics

Due to the small number of stocks and small marketcaps, quantitative analysis is challenging in the early years.  Below are the market cap distribution results from 1994 to 2013. Since there is only 1 stock in July 1994, we start our backtest from July-1995.

2014-11-06 11_33_29-Microsoft Excel - CHN ADR stats 2014.11.06.xlsx
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Summary Statistics

The statistics look promising. The value-weighted strategy generates a 14.63% CAGR, which significantly outperforms both the Shanghai composite index and the SP500 total return index. However, the volatility is insane: ~40% volatility, ~78% drawdown.

2014-11-06 11_37_12-Microsoft Excel - CHN analysistool_v30.xlsm
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Note that the CHN_ADR_VW is more correlated to SP500 (50.24%) than to Shanghai Index(34.00%).

Invested Growth

2014-11-06 11_37_47-Microsoft Excel - CHN analysistool_v30.xlsm
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Major Drawdown Problems? …YES!

Historically, buying and holding Chinese ADRs suffers serious pain. It was scary enough during the 78.20% drawdown between 07-1997 and 08-1998. However, there was a 35.97% drawdown 3 months later, from 11-1998 to 02-1999. What’s more, 4 months later, investors suffered  a 52.09% drawdown form 06-1999 to 02-2000. You think this is the end? NO! From 04-2011 to 11-2012, there was a 35% plus drawdown. This type of volatility would test the will of even the most hardened investor.

2014-11-06 11_38_53-Microsoft Excel - CHN analysistool_v30.xlsm
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

 

 Conclusion

On Friday, for the first time in more than two years, the Chinese central bank cut the interest rate. The market reacted positively. Look at the following ETFs which track the China mainland market: big surge!

2014-11-21 16_46_23-3-BLOOMBERG

For story based investors, they might be excited by this news. However when you look at the evidence, we know the Chinese markets can be extraordinarily volatile and it was better to buy Chinese ADRs instead of the Shanghai Index.

Be careful as you tread into the Chinese markets…

 

 


Note: This site provides NO information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.


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Please remember that past performance is not an indicator of future results. Please read our full disclosures. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.


Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Yang Xu

Mr. Xu is currently a managing member of Alpha Architect, where he leads the capital markets group and assists in quantitative research. Mr. Xu has unique skills related to "big data" analysis. His recent research investigates various proprietary trading algorithms, tactical asset allocation models, and longer-term security selection models. Prior to joining Alpha Architect, Mr. Xu was a Principal Data Analyst at Capital One, where he was a member of the Basel II data analysis team. Mr. Xu graduated from Drexel University with a M.S. in Finance, and from the University of International Business and Economics in Beijing, China, where he earned a BA in Economics.


  • Michael Milburn

    Wes, Have an off-topic question. Do you have any pointers for studies that look at

    A) very long term buy/hold investing – like looking at buy stocks today that have certain fundamental characteristics, and just hold them for 5, 10, 20+yrs. Basic question here is that most studies seem to often show more frequent cycling of positions seems to help returns a bit, but guys like Buffett just buy and hold for decades and I wonder if maybe something changes on that level of time.

    B) studies that look at buying stocks based upon relative ranges of their own past fundamental multiples (example: lowest to highest P/bk, PE, PS, in 5-7 yr period or similar? Note relative to their own historical multiples – not relative to the universe of other stocks, but just to themselves? Idea is if a stock is trading at a low or high fundamental multiple vs. itself (regardless of whether it’s low or high compared to the market) – is that a quantitative indicator w/ any predictive ability?

    I did a few google searches but can’t seem to even find the right search terms, but if you have any pointers I’d appreciate.

  • A) Thaler has a paper on long-term reversals where they have 5-year holds on poor performing stocks. Typically folks don’t look at long horizon because the sample size is so small and it hard to disentangle luck from skill. For example, if we are looking at a 25year holding period and we have 50 years of data, we have 2 observations…that isn’t enough.

    B) I think Chris Brooks has done this: http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=14685

  • Michael Milburn

    thanks Wes, good info. I think this Brooks paper might be one:

    Decomposing the Price-Earnings Ratio

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=739665

  • Sebastien Hitier

    Wow perf x5 better than sp500… What happens with absolute momentum to switch back to spy then to treasuries? If you can send me the monthly returns, I am happy to check.