Pursuing Lasting Progress in Emerging Markets®

Prevailing Winds

Have Foreign-listed Chinese Stocks Been a Bad Deal for Investors?

Prevailing Winds is a China-focused blog written by Nicholas Borst, Director of China Research at Seafarer. The blog tracks the economic and financial developments shaping the world’s largest emerging market.

First impressions are hard to shake, and many U.S. investors’ first encounter with Chinese stocks was tainted by fraud. Starting in the mid-2000s, a wave of small Chinese companies listed on the New York Stock Exchange and NASDAQ via a process called reverse merger.

Many of these companies were highly speculative, and a public listing via reverse merger allowed them to bypass the standard disclosure requirements that are part of the initial public offering (IPO) process. A great number of these stocks initially soared, driven by speculation and hype over China’s economic potential.

Chinese reverse merger stocks eventually attracted the attention of short sellers who highlighted the serious fraud and corporate governance problems present in many of the companies. This led to a collapse in share prices and the delisting of many companies.

Figure 1 shows the performance of an index of Chinese reverse merger stocks during this six year period. While the index shows a cumulative loss of around -6%, an investor who bought these companies at the height of their valuation would have lost more than half of his or her money.

Figure 1. Bloomberg China Reverse Mergers Index 12/31/08 – 8/21/14 (12/31/08 = 100)
Source: Bloomberg.1
Past performance does not guarantee future results.

In the 2010s, the number of reverse mergers declined substantially, and the makeup of Chinese companies listing in the U.S. evolved to mainly encompass larger firms that have undergone the traditional IPO process.

Nevertheless, controversy continues to shadow Chinese companies listed in the U.S., including:

Given this history and the persistent controversies, some loud and public voices have argued that Chinese companies continue to exploit U.S. capital markets at the expense of investors. Such sentiment helps explains the muted response from the investment industry to efforts by the U.S. government that would potentially force delisting of these companies.

As with many things, a look at the underlying data can help provide clarity and context. Figure 2 uses indices to compare the performance of foreign-listed Chinese stocks with three groups of equities over the past decade: mainland-listed Chinese stocks, global stocks (ex-U.S.), and U.S. stocks.

Figure 2. Foreign-listed Chinese Stocks Relative to Other Equity Indices 8/1/10 – 7/31/20 (8/1/10 = 100)
Source: Bloomberg.
Past performance does not guarantee future results.
Foreign-listed Chinese Stocks (excluding reverse merger companies)
New York-listed Chinese Companies MSCI Overseas China IMI Gross Total Return Index USD2
Foreign-listed Chinese Companies (listed in Hong Kong, New York, and Singapore) MSCI International China IMI Gross Total Return Index USD
Other Equity Indices
Mainland-listed Chinese Companies MSCI China A Onshore Gross Total Return Index CNY
Global Stocks (ex-U.S.) MSCI ACWI ex-USA Gross Total Return Index USD
U.S. Stocks S&P 500 Index

Figure 2 above reveals several important findings:

There are several important caveats to this analysis to keep in mind:

Corporate fraud invariably attracts significant attention and many of the early wave of reverse merger Chinese stocks were rightfully exposed for their corporate failings. However, as a whole, foreign-listed Chinese firms, especially those listed in the U.S., have provided attractive returns for investors over the past decade. Attempts to broadly label foreign-listed Chinese firms as fraudulent and damaging to U.S. investors are not supported by the facts.

Nicholas Borst,
The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.
As of June 30, 2020, the Seafarer Funds did not own shares in the entities referenced in this commentary.
  1. The Bloomberg China Reverse Mergers Index was discontinued effective August 22, 2014.
  2. The index contains a small weighting of Chinese companies listed in Singapore, accounting for around 0.50% of the total index.