China’s Healthcare ETF: The Next Limelight

Healthcare Author: Mengyao Zhang May 10, 2020 11:33 PM (GMT+8)

Amid the COVID-19 pandemic, the Chinese Shenzhen stock market was the only market with a positive growth rate (in Q1 2020). In the meantime, China’s healthcare industry has got more of a spotlight on the global stage.

Herbal plants in the beakers are observed for pharmaceutical experiment. Image credit: Chuttersanp/Unsplash

The continued pandemic has whirled around the globe, leaving economic slumps and a desire to find solutions and explanations – and apportion blame. Hesitation is rife over the outlook of the coming one or two years. However, while the western market is struggling with frozen growth, stagnant investment processes and a deteriorated market for small- and medium businesses, the Chinese market has gradually picked up its usual hustle-and-bustle.

One of the most remarkable performances among all the Chinese industries since the outbreak last December is that of the healthcare industry. It outperformed not only other domestic industries boards and its Nasdaq- and NYSE-listed peers, but also protected many China Healthcare ETF holders from severe financial distress, similar to 2018.

The first exchange-traded fund (ETF) was launched on January 23, 1993 and the last few years have witnessed their maturity in the US market. Praised for many merits, e.g., wide diversity, lower costs and tax efficiency, etc., ETFs have been deemed an ideal asset for individual investors and popular products for traders.

Indeed, faced with this global ‘black swan’ issue, the ETF funds have proved their resilience in the suffering marketplace.

China healthcare-focused ETFs and their underlying indexes

The ETF market started late in China, partly because of strict market regulations, partly investors’ insufficient expertise. Even though the Chinese ETF market is quite underdeveloped compare to the western ones, Chinese companies are usually blended into some international ETFs. The tremendous domestic market, stable social environment and growing consumption capabilities, etc. – all these merits of the emerging market are winning the favor of global investors.

The MSCI China Health Care Index was launched on January 1, 2001, to measure the equity performances of large- and mid-cap Chinese companies engaged in the health care sector. It covers securities listed in Mainland China, Hong Kong and the US (technically, Chinese healthcare companies across H shares, B shares, P chips, Red chips and A-shares since June 2018). Since April 30, 2020, this healthcare-specific index has been exposed to 79 companies, at a market cap of HKD 789.597 million, and has outperformed MSCI China since July 2018.

Together with the general health care index, related MSCI China healthcare indexes are underpinning two ETFs, KURE and CHIH, with a focus on China’s healthcare sectors. Both, listed in NYSE Arca, are based on the same securities pool of Chinese-listed healthcare companies, but are very different on the constraints of their underlying indexes.

KURE, registered on January 31, 2018, seeks to measure the performance of MSCI China All Shares Health Care 10/40 Index by picking out 80 out of 81 portfolio companies. Comparable to KURE, CHIH is another ETF with a similar fundamental index – MSCI China Health Care 10/50 Index, holding 35 out of 79 portfolio entities.

MSCI is not the only institute that has realized the value of the healthcare sector in this emerging market. A half month after the launch of KURE in early 2018, Loncar Funds established the Loncar BioPharma Index (LCHINA: INDEXNYSEGIS), an index of 36 securities specializing in China’s biopharma industry, and six months later introduced the related ETF, CHNA on Nasdaq.

Instead of full exposure to a wide range of X-shares, Loncar China BioPharma Index only screened from China-related biopharma companies that were Nasdaq-listed and Hong Kong Stock Exchange-listed, with over USD 200 million market capitalization, as explained in the prospectus. The reconstitution is arranged every second Monday in February and August to weighted constituents by their market capitalization equally.

Most promising healthcare segments in China

The year of 2018 witnessed all these ETFs going public, a milestone when these Chinese healthcare companies gained more extensive exposure to overseas investors. Indeed, the growing aging population, accelerated urbanization and income growth and ever-open healthcare reform policies all convey very positive messages about the potential of this country’s healthcare future.

But, faced with the broad sector, which is on track to be a good one, is investment simply a matter of common sense? Even though MSCI breaks the whole brick into fine segments, the ETF constituents vary a lot.

KURE, the ETF backed by MSCI China Health Care 10/40, categorizes the Chinese healthcare ecosystem into six perspectives: patent and generic pharmaceuticals, medical equipment production, hospital administration, biotechnology, TCM (traditional Chinese medicines) and healthcare IT. In its portfolio, most weighted constituents are from pharmaceutical and biotechnology, representing 33.59% of the total fund as of March 31, 2020.

Its comparable ETF, CHIH, has a slightly different matrix – it doesn’t segregate TCM solely but merges into pharmaceuticals, and especially adds a vertical named ‘life sciences tools & services.’ Among its top ten index constituents, it shared a similar structure with KURE of three pharmaceuticals, four biotechnologies, one medical device and one healthcare service IT, as of March 31, 2020.

MSCI-backed ETFs are all trying to make the best out of high return and diversified risk. On the contrary, CHNA is a unique fund with a unique preference of the biopharma business in China. Eyeing the long-term prospectus of this field as early as February 2018, Loncar China BioPharma Index adopted a different screening mechanism to keep risks in control, with investable portfolio companies only listed in Nasdaq and HKSE and hurdle market cap of USD 200 million.

The single-basket portfolio violates the universal diversification rule. But with a detailed look into this strategy, many biopharma names have a robust foundation, such as R&D spending, or innovative medicine in the pipelines,  to boost massive values soon.

From pharmaceutical to biopharma

The pharmaceutical segment is the most substantial portion among all these indexes and ETFs. In contrast with the top ten constituents of KURE, CHIH and CHNA, there is a wide overlap of constituent companies.

Wuxi Biologics (Cayman) (2269: HKSE), WuXi AppTex Co (2359: HKSE) and Sinopharma Group (1177: HKSE) – three biopharmaceuticals – are all heavily weighted in these ETFs. When it comes to the typical pharmaceutical area without cutting-edge biotechnology, the two MSCI-generic ETFs have three additional overlapping companies, Jiangsu Hengrui Medicine (600276: SH), CSPC Pharmaceutical Group (1093: HKSE) and Alibaba Health Information (241: HKSE). 

Biopharmaceutical products are explained as any pharmaceutical drug product manufactured in, extracted from, or semi-synthesized from biological sources. So, biotechnology allows a typical drug maker to be tagged as ‘high-tech’ together with a good reputation. Another commonly acknowledged fact about all biopharma players is that it takes a long time to monetize all those R&D investments – some listed companies haven’t benefited yet.

However, for investors well-acquainted with the biopharma field, the real valuable assets are the R&D capability of innovative drugs to deal with rare critical diseases. In CHNA’s portfolios, eight out of the top ten most weighted companies are biotech pharmaceuticals, with CanSino Biologics (6185: HKSE) at 5.58% the most held. I-Mab (IMAB:Nasdaq), a biotech that just went to IPO this early January, is still expecting its first revenue fruit on the way.

The Chinese healthcare industry, a large topic that came into the world’s sight last 2018, has been reported on over and over again amid the continued COVID-19 outbreak. After the large-scale domestic lockdowns, the economy has gained vitality via telehealthcare and now is moving on to its putative new normal.

It seems that, as the way the investment world perceives the economy of China grows more divergent, one group remains trapped in a haze of prejudice while some minorities are trying to understand potentially healthy  – and health-giving – areas, with an open mind.