China has been home to the most extreme economic growth in human history. In four short decades,
the nation has gone from a struggling backwater filled with poverty to this, a nation of glistening
skyscrapers and more Gucci stores than you can poke a stick at.
The driver of this growth has obviously been its embrace of the free market and opening
itself up to international trade.
The nation has always had huge potential, given that historically for 1,900 out of the
last 2,000 years it has been the largest economy on earth, but now it is finally realizing
that potential once again.
Seeing this sustained growth people are obviously keen to jump on board, millions of dollars
are been made by millions of people and any logical investor would be foolish to not have
exposure to the largest growth market in the world right?
I spend a fair amount of time chatting to channel viewers on discord, Patreon, and even
in the comments section of the video’s and it’s probably one of the questions I see
the most, Mr economics man how can I invest in Chinese companies stock?
Now I don’t want to sound rude, and I promise I absolutely mean this in the nicest possible
way, but if you have to ask someone on youtube how you can invest in Chinese equities, you
absolutely should not at all be investing in Chinese equities.
And in fact even for more seasoned investors, the market for Chinese companies is not exactly
the promised land of double-digit annual returns you may think it is.
This is because there are a few major problems that have yet to be overcome, the stock market
in China is both too regulated and not regulated enough. Which sounds silly but let’s explore
it by looking at this problem piece by piece.
How is the Chinese stock market over-regulated?
How is the Chinese stock market under-regulated?
And why does this mean that most investors probably shouldn’t be investing in these
markets?
And alright alright, if after all of this you are still interested in learning how to
actually buy shares in china I will show you how, but don’t say I didn’t tell you so.
Intro add
Now some people may not know this, but the varios stock exchanges around the world are
mostly non-government companies. Something like the New York Stock Exchange for example,
which is by far and a way the largest exchange in the world is just a regular old company.
They are just a marketplace provider, similar in many ways to ebay, only instead of facilitating
the exchange of unwanted Christmas gifts, they facilitate the exchange of shares of
publicly listed companies.
Companies like the New York Stock Exchange actually do a really good job of looking like
a federal entity, they work in an old historic looking building plastered in american flags,
reminiscent of any given government building in DC, but they are not, they are a regular
company the same as any other.
The new york stock exchange in particular is actually owned by another company called
intercontinental exchange or ICE for short, but to be honest they have become less and
less keen on this abbreviation over the years.
This company actually owns similar stock markets all over the world, which gives listing companies
the ability to be traded on more exchanges than just the one that sits on wall street
in new york.
What this means is that you can actually buy shares in the new york stock exchange, as
well as buy shares on the new york stock exchange? And guess where you can buy shares in the
new york stock exchange, that’s right, on the new york stock exchange…
Confused? Good, because to be honest the whole process is actually far more simple in
The Chinese markets
There are two dominant stock exchanges in china, the shanghai stock exchange and the
Shenzhen stock exchange.
These two markets actually draw an interesting parallel between the new york stock exchange
and the nasdaq respectively. In that one is a fair bit larger but tends to list stocks
in more established industries and the other is slightly smaller but has a larger listing
of up-and-coming entities like tech companies.
It also must be noted that the Shenzhen stock exchange is both geographically and financially
very close to the hong kong stock exchange.
Now the big difference between these two mainland exchanges and their western contemporaries
is that they are owned by the government. The shanghai stock exchange is a government
agency just the same as the tax department or military.
Given that China is at least in theory a communist state, the government sees the exchange of
stocks as a public service that they will handle. Now this causes a few key issues.
For starters it means that the government has control over what companies get listed
and what companies do not. Now in a perfectly fair and impartial system, this wouldn’t
necessarily be an issue, but in this particular market, eeh it might be.
The other problem it causes is that the barriers to entry are just more difficult to get through.
There are a long list of requirements to be publicly listed above and beyond the normal
requirements of a privately owned company, this is true even in the united states, these
requirements will be broken up into the requirements of the federal government and the requirements
of the exchange.
Normally to meet all these requirements the businesses that are being listed will employ
the help of an institution an investment bank, who will also help ensure the process goes
smoothly, aswell as underwriting the deal if it does not.
What this means is that there are multiple entities involved that stand to make a profit.
The investment bank and the stock exchange are all directly compensated by how many listings
they can get on the board.
In China this isn’t really the case, the exchanges are funded by the government so
if a business doesn’t get listed or it takes 4 years for it to reach an IPO, oh well.
The same sorts of limitations are true for when a company actually does manage to get
listed. Rules around things like ownership structures, reporting standards and who can
buy what shares are very limited.
For example, buying shares directly as a foreign investor is not allowed without significant
vetting and even if this is approved and you are limited in your selection.
For example, I (mr economics man) am an Australian citizen, if I wanted to invest directly into
an american company, no problem I just contact my brokerage and tell them to buy apple or
amazon or bank of america or whatever, it’s just as easy if not easier than buying shares
on the Australian stock exchange.
Now if I wanted to buy shares directly on the shanghai stock exchange that’s a very
different story. Chances are 99% of you watching would not be eligible at all because you need
to meet atleast one of these criteria.
Have a permanent China residence card;
Be an employee of a listed company, and be participating in the companies equity incentives.
IE senior foreign executives that get paid bonuses in stock options.
Work in china.
Or be the owner of a corporation with operations globally aswell as within china, and for those
of who meet this last standard… how you doin… patreon dot com.
Even if you do meet these criteria you have to go through a robust background check and
you are only able to buy non-voting shares in the companies. Meaning that you will share
in profits and capital appreciation but you can’t vote on company decisions or who sits
on the board. China really does not want any foreign influence in their major companies.
For those of you who don’t meet these criteria, well you are out of luck, sort of, but don’t
worry there is a way I promise.
Anyway, these severe limitations mean that these exchanges are not that great at raising
capital, which is in essence what stock exchanges were made for. Because of this, you will find
that the largest listed companies are all mostly state corporations that have a small
share of equity, something like 10% owned by the general public.
Since these corporations have other objectives besides simply being profit generators there
performance is ehhh. Less than amazing, or certainly less amazing than you would expect
from a nation with such strong growth.
We have said it many times before on this channel that the stock market does not equal
the economy, and almost any time we have said it, its been because the stock market has
been doing really well while the wider economy has been doing really poorly, in china it’s
almost the opposite.
Due to these limitations you will find that even most chinese investors don’t dabble
as heavily in the stock market as their western peers, preferring instead to accumulate real
estate, but that’s a topic for another video, spoiler alert you probably shouldn’t buy
real estate in china either.
Now weirdly enough this over-regulation has caused a major problem with
Underregulation
Businesses need funding, that’s how they grow and expand and conduct research and development,
it’s why the stock market exists.
Before shares people couldn’t invest into a business without being a partner in that
business which meant that they were liable for issues in the business. If the business
gets sued, or can’t pay its loans it might be this investor’s house on the line. Needless
to say, this wasn’t very popular, and it meant that some ventures just didn’t get
the funding they needed to get off the ground.
The same is true in china, and there are all manner of companies operating in the nation
that want funding to expand, but will find it difficult to get listed on Chinese stock
exchanges.
So what are they to do? Well list on another stock exchange obviously.
Historically the hong kong stock exchange has been a popular choice for this, given
it’s close proximity to mainland china as well as it’s distinction as a separate economic
entity. But as most of you will know the distinction between the regions has been blurring more
and more every day.
Because of this more and more companies have been looking to places like the new york stock
exchange, which has actively been encouraging this participation. Remember the NYSE is a
company, they want to get listings so that they get paid.
But this causes some other issues for potential investors.
Cooking the books, or reporting financial figures that are factually untrue, has been
a major problem for these companies. Now the listing process of any given exchang is supposed
to account for this.
Typically the exchange and the underwriter they go through to get listed would be liable
for any misinformation that goes into an offering so both of these institutions do thorough
audits before anything ever makes it to the trading floor.
However there is a sneaky back door solution available to companies that may or may not
be completely honest operations.
A reverse merger is when a private unlisted company, buys up control of a publicly listed
company and then merges with it to make one big publicly listed company.
So if you were a devious and potentially fraudulent business man that wanted to take advantage
of the hype surrounding the chinese economic miracle this is what you would do.
Create a business in china, doing anything, or nothing at all, it really doesn’t matter
nobody s going to check. Just make sure you have a legit looking warehouse and a website
that checks out.
Then you get your accountant to start generating reports that look like the business is receiving
massive revenues and making massive profits keep this up for a few years and then you
move on to the reverse merger stage.
At this point you find a company that is listed on an exchange that you want to take advantage
of, in this case, let’s say your going big and go after the holy grail... the new york
stock exchange…
You are going to want to find some small company with a low market capitalization, maybe some
old sickly business in an irrelevant industry, let’s just call it Dunder Mifflin.
Now some companies like dunder miflin here can have a market capitalization as low as
25 million dollars which is obviously a lot, but to complete a merger, the dubious businessman
only need’s a controlling interest in the company, so it’s possible to get away with
as little as 51%.
Once this company is acquired the two will merge to form a new entity that will maintain
it’s listing on the NYSE. At this point the previous public business can be completely
liquidated.
Anything that was previously owned will be sold off to try and recoup some of that 12
million dollars, and depending on what the business had in terms of real estate, inventory
and hardware, this could actually earn back a good majority of that cash.
Once this is done the business may change its name to reflect something more reminiscent
of a chinese company. Let’s call it the totally legit manufacturing company of china,
cool.
Then it can be promoted to new investors as a way to directly get into an up and coming
chinese operation without having to jump through all the hoops of investing through something
like the shanghai stock exchange.
Some investors might still be weary, but that’s ok you can just pay off some public figure
like bill Clinton to speak about the growth of the chinese market, and yes this actually
happened.
With this, unsuspecting investors will start pouring money into this stock and now it’s
finally time to capitalise. You can do this in 2 ways.
The first is that you take all of this invested capital and use it to pay yourself a massive
salary as the CEO or use it to pay another business that you own for consulting expenses.
The second way is just to sell off your own shares on the public market once they have
appreciated to a nice healthy vauation.
A good dodgy businessman will do some combination of both of these.
Now you might be asking well isn’t this illegal? And yep it absolutely is, but typically
the people involved in pulling off these operations have connections that will see that they never
see any punishment for these types of actions. If worse comes to worse they can always launder
your money out by following the steps in our video here.
Sounds great right? Now I bet you are asking yourself
How do I invest?
Well there are a few ways to get exposure to chinese companies, the first is of course
to go into business directly with a business partner in china. This is again highly risky
but it is obviously the most direct method.
The second is to buy up companies listed in exchanges outside of mainland china. Businesses
like alibaba, tencent, and xiami all have listings on international exchanges in order
to attract wider funding.
And finally you can get access to stocks exclusively traded on Chinese exchanges by using an exchange-traded
fund or an ETF. This is basically just buying up a security which in turn buy up shares
on these chinese exchanges through a company that has the green light to do so by the Chinese
government.
Ishares through Blackrock has this on the Nasdaq, listed under the ticker MCHI, and
there are plenty of other examples out there.
But here is the last word of caution, yes china has seen amazing growth and it will
no doubt continue to grow into the future, I can see that, you can see that and any other
investor out there can see that, this means that the anticipation of future growth in
the economy has already been priced into all of these shares.
That’s why the performance of even these well-managed indexes has been good, but not
quite as mindblowing as the rest of the economy.
Outro add