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.
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.
- 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.
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.
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.
Note that the CHN_ADR_VW is more correlated to SP500 (50.24%) than to Shanghai Index(34.00%).
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.
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!
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…
- 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. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).
- Join thousands of other readers and subscribe to our blog.
- This site provides NO information on our value ETFs or our momentum ETFs. Please refer to this site.