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What Rising Geopolitical Risk Means for China Stocks

·4 min read

Legendary value investor Warren Buffett and his longtime business partner Charlie Munger, the vice chairman of Berkshire Hathaway Inc., have made fortunes with a contrarian “value” investing approach, but market remain much more cautious when it comes to the Chinese e-commerce giant Alibaba and Chinese equities in general. 

Munger, a spry 98-year-old who recently stepped down as Daily Journal Corporation’s chairman, is also a director of Costco Wholesale Corp.

BABA is not only one of Munger’s favorite value investments, but also the top holding of the iShares China Large-Cap ETF (FXI), the most liquid fund with exposure to the economic giant. Yet FXI has underperformed the U.S. stock market, which is likely to continue given the geopolitical landscape.

Munger Holds BABA Despite Poor Performance

While Munger values BABA’s business far more than the stock price, the market does not agree.

He last purchased BABA shares in the final quarter of 2021. His first-quarter 2022 disclosure showed Munger sold half of the long position, or 302,060 BABA shares. At the end of the second quarter, his DJCO held 300,000 BABA shares worth $33.4 million at $111.38. And at the $90.95 level on Aug. 8, the investment is now worth $27.285, an 18.34% decline since June 30.

BABA shares closed 2021 at $118.79 and have made lower highs and lower lows since reaching a record $319.32 high in October 2020.

ETF Exposure

FXI holds a significant number of BABA shares:

 

Source: Yahoo Finance

 

FXI holds 9.39% of its net assets in BABA shares. At the $29.90 per share level, the ETF has over $5.253 billion in assets under management and trades an average of more than 29 million shares daily. FXI charges an expense ratio of 0.74%.

The S&P 500 is the most diversified U.S. stock market index and the bellwether for the overall equities market. The S&P 500 reached its pandemic-inspired low in March 2020 at 2,191.86. The index closed 2021 at 4,766.18, a 117.45% gain. At the 4,142.97 level on Aug. 8, 2022, the index was 13.08% lower in 2022.

BABA shares fell to $169.95 in March 2020 and were at the $118.79 level on Dec. 31, 2021, a 30.1% decline. At the $91.19 level on Aug. 8, BABA shares were 23.2% lower in 2022.

 

Source: Barchart

 

Source: Barchart

 

The chart shows FXI traded to a low of $33.10 in March 2020 and closed 2021 at $36.58, a 10.5% rise. At $29.87 on Aug. 8, FXI was 18.3% lower in 2022.

BABA and FXI have underperformed the U.S. stock market since the March 2020 pandemic-inspired lows. They have also lagged the U.S. stock market since the end of 2021.

 

Source: Barchart

 

Broader Chinese Stock Market 

The overwhelming reason Munger and other investors turn to Chinese over U.S. stocks is the value proposition. China is the world’s second-leading economy and the most populous country.

But the performance of BABA and FXI shares has been a compelling reason for contradicting the almost century-old value investor. The early February “no-limits” agreement between Chinese President Xi Jinping and Russian President Vladimir Putin put the U.S. at odds with the two nuclear powers. Russia’s invasion of Ukraine pushed the sides further apart.

The Speaker of the House of Representatives’ visit to Taiwan last week further escalated tensions, infuriating China’s leadership. In the aftermath of Nancy Pelosi’s trip, China cut off some diplomatic channels with the U.S. The potential for further deterioration is high and could lead to the delisting of Chinese stocks from U.S. exchanges.

Munger is betting that economics and value will cause his investments to appreciate over time. However, the geopolitical landscape continues to point to risk in Chinese assets. As of Aug. 8, geopolitical risks have been far more influential for BABA and FXI shares.

Investment in BABA and Chinese stocks requires patience and perseverance in the current environment. Swimming against prevailing trends can offer some of the most exciting rewards, but the risk is always a function of potential profits in stocks and markets across all asset classes. There are never guarantees in markets.

"Be fearful when others are greedy and greedy when others are fearful," Warren Buffett once said.

In August 2022, the market remains fearful of BABA and Chinese stocks.

The geopolitical risks created by the Chinese-Russian alliance, Russia’s invasion of Ukraine and tensions surrounding Taiwan could continue to cause investors to shy away from investing in Chinese equities.

Since FXI is the most liquid Chinese large cap ETF product holding leading companies, the risks are elevated. China or the U.S. could delist select shares or all Chinese-owned companies over the coming months. While Munger and other value-seeking investors see the value proposition, it comes with commensurate risks that any ETF investor needs to consider.

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