Will China kill its golden geese? A deep dive into the Betashares Asia Technology Tigers ETF (ASIA)

The Asian technology sector has suffered a pullback in recent months, even as global equity markets – and the global tech sector in particular – have continued to power ahead. This suggests the pullback largely reflects regional factors – namely the tightening of regulatory scrutiny by Chinese authorities of its major technology companies.

The Asian technology correction has had an impact on the BetaShares Asia Technology Tigers ETF (ASIA), which has pulled back from highs reached in February this year. However, it is worth noting that while the recent focus has been on developments in the Chinese government’s regulation of the sector, ASIA provides broad regional exposure, with 50% of the portfolio invested in companies outside of China (as at 30 June 2021).

This note explores the issue, and suggests recently volatility should be considered part and parcel of the inherent volatility associated with this especially dynamic part of the global equity market.

Asian technology pullback

As evident in the chart below, the Asian technology sector – as proxied by the BetaShares Asia Technology Tigers ETF (ASIA) – has experienced a pullback since mid-February. Initially this appeared to be part of the ongoing global rotation from growth to value stocks, as the global economic recovery gathered steam, and sectors hardest hit by the COVID crisis enjoyed a relative performance rebound.

This was also evident in a period of consolidation for the tech-heavy U.S.-based NASDAQ-100 Index (tracked by the BetaShares NASDAQ 100 ETF (NDQ). In fact, the pullback in Asian technology could also be explained by its relatively strong performance – at least compared to the NASDAQ-100 – late last year, due to a rotation towards emerging markets over developed markets as part of the value rotation.

But more recently, the performance of Asian technology has continued to lag, even as growth stocks – and the NASDAQ-100 – have rebounded, suggesting local factors are increasingly to blame.

ASIA vs. NDQ Performance

Index performance does not take into account ETF fees and costs. You cannot invest directly in an index. Past performance is not indicative of future performance of any index or ETF.

Importantly, however, this pullback has not been reflected in a weakness in corporate earnings. As evident in the chart below, forward earnings for companies in the Datastream Non-Japan Asia Technology Sector Index (many of which are also held in the ASIA ETF) have continued to increase strongly in recent months, even more so than that evident with the overall global technology sector.

Forward earnings

Index performance does not take into account ETF fees and costs. You cannot invest directly in an index. Past performance is not indicative of future performance of any index or ETF.

China’s regulatory crackdown

So what are the key issues concerning investors in the Asian technology space? It’s largely down to recent regulatory crackdowns by the Chinese government. Since late last year – starting with an anti-trust review of online marketplace Alibaba – a range of Chinese tech companies have faced new rules and scrutiny by Chinese authorities.

All up, the core aim of the regulatory crackdown appears to be to stamp out excessive anti-competitive practices in areas where companies have significant market power. This applies to the treatment of both workers and suppliers. In the main, this is not unlike some of the moves being attempted in Western Economies – the only difference is that China, being China, can impose new rules swiftly without having to work them through the democratic process.

In the case of the for-profit education sector, it reflected a concern about growing cost pressures faced by households, which could limit their ability to have extra children.  Earlier this week China’s security regulator met with leading investment banks to argue they should not “over interpret” changes in the education sector, arguing this was a sector specific issue.

Other aims of the crackdown appear to be to ensure potentially sensitive data on Chinese citizens and officials is secured within China and is less likely to be open to foreign commercial or national intelligence access. Last but not least, China’s central government is probably seeking to remind China’s new breed of – often outspoken – tech billionaires who ultimately is boss. As the fortunes of these companies still rest heavily on being able to do business in China, they face little choice but to toe the line in terms of government demands.

China aside, it should be noted that 50% the ASIA’s ETF exposure is currently in companies outside of China, with South Korea and Taiwan companies accounting for almost a further 40%. Indeed, the top two companies in the ASIA ETF at present are Taiwan Semiconductor Manufacturing and Samsung Electronics, with recent share price performance of these companies also being negatively affected in recent months by lingering global supply bottlenecks, especially with regard to semiconductors.

Focusing on the long term

All that said, the computer chip shortage should soon pass, and demand over the longer-term is likely to remain very strong.  Regulatory crackdowns in China, moreover, are nothing new – they have been seen in the tech area most recently in 2018 and in a range of other sectors (such as steel making, finance and  property development) from time to time. This appears to be the price of doing business in China!

So far at least, it has not stopped the Chinese economy  – or these particular sectors – continuing to grow strongly over recent years. Indeed, global demand for consumer goods and semiconductors – where Asia plays a key role in production – has increased strongly over the past year in line with the V-shaped global economic recovery.

Long-term, growth in private-sector led innovation is critical to China’s continued economic success, especially in the key areas of consumer services and technology more broadly. Indeed, as previously outlined here, in many ways Asia has already technologically leap-frogged the West in terms of technology adoption, and the future of the sector appears bright given the large and growing Asian middle class. Many of Asia’s tech giants, moreover, enjoy diverse revenue streams, meaning a limit on activities in certain areas may have only a limited impact on overall profitability.

In the case of China especially, it likely wants to retain tight control of this burgeoning sector, without killing its golden geese.

For longer-term investors, this suggests little has changed, or is likely to fundamentally change, in terms of the long-run strong outlook for the Asian technology sector. In fact, moves to increase competition in the Chinese technology sector could provide added dynamism and growth opportunities for small companies, which underlines the benefits of having diversified exposure – such as through the ASIA ETF – across many companies within the sector.

Long term investors in Asian equities, like investors of equities more generally, need to be comfortable with, and understand that short term volatility is part and parcel of investing. Despite such volatility being alarming to live through, disciplined and patient long term investors are typically rewarded for ‘staying the course’.

A buying opportunity?

All up, it seems likely that the price impact of the latest round of regulatory risk now being absorbed by the Asian technology sector will eventually fade. As such, the current period of price weakness may well represent a buying opportunity for long-term investors who still see potential in this growth thematic.

As evident in the chart below, the Asian technology sector generally trades at a price-to-forward earnings discount to the global (largely U.S. dominated) technology sector. Since 2003, that discount has averaged around 15%, whereas by late-July it had increased to 30%.

Price to Forward Earnings (PE) Ratios

Index performance does not take into account ETF fees and costs. You cannot invest directly in an index. Past performance is not indicative of future performance of any index or ETF.