Introducing WisdomTree China ex State Owned Enterprises Index

In a previous blog post, we discussed the characteristics of Chinese state-owned enterprises and the growing interest that some investors have expressed in avoiding or limiting their exposures. State-owned enterprises are typically defined as companies that are either wholly or partially owned or operated by a government. Some investors believe that government ownership can negatively impact the operational aspects of a company because government-owned companies might be influenced by a broader set of interests, beyond generating profits for shareholders. The Wall Street Journal recently reported that the Chinese government is seeking reforms within its state-owned enterprises in order to make them more profitable. This reform is speculated to be accomplished through consolidation and not through a relaxing of the state’s control, which many argue is needed. The newspaper reported: To be fair, there are certainly price levels at which these state-owned companies can become very inexpensive, and all the bad news can become reflected in the prices such that they perform very well going forward. But given the dominance of many state-run companies (more than 70% in popular Chinese benchmarks), WisdomTree thought it prudent to offer an alternative view of China—without state-run companies. Therefore, we introduce our new Index, the WisdomTree China ex-State-Owned Enterprises Index, which is designed to measure the performance of broad-based Chinese stocks that exclude state-owned companies. To WisdomTree, state-owned enterprises are defined as those having government ownership of more than 20% of outstanding shares.   Index Methodology The Index employs a modified float-adjusted market capitalization-weighting process to target the performance of Chinese stocks that are not state-owned enterprises.   • Eligible Universes: Must be a member of the WisdomTree Emerging Markets ex-State-Owned Enterprises Index and be incorporated or domiciled in China. • State-Owned Enterprises: Companies with more than 20% ownership by government body are excluded. • Minimum Market Capitalization: $1.0 billion. • Weighting: Modified float-adjusted market capitalization. • Holding and Sector Caps   WisdomTree China ex-State-Owned Enterprises Index Characteristics For definitions of terms and indexes in the chart, please visit our glossary. • Valuations Tell a Mixed Story: Looking at dividend yield and price-to-earnings (P/E) ratios of the various Chinese indexes above would lead an investor to believe that the non-state-owned part of the market is priced higher. But if considering profitability metrics like return on equity and return on assets, an investor could conclude that non-SOEs are more reasonably priced. WisdomTree believes that SOEs generally trade at lower valuations due to the perceived risk of government involvement; the most difficult part is determining the right level of discount warranted.   • Information Technology and Consumer Sectors Rise to the Top: Given the Chinese government’s low amount of involvement in the Information Technology sector and Consumer sectors (Discretionary and Staples), we are not surprised that these sectors become some of the largest weight after the state-owned enterprises have been removed. WisdomTree believes these sectors will continue to be important to focus on in the future as China’s standard of living increases and its large population base transforms into consumers.   • Under-Weight Financial Sector: Given the Chinese government’s high amount of involvement within the Financials sector, specifically within the country’s large banks, it is reasonable to expect this sector to make up a lower percentage after state-owned enterprises have been removed. WisdomTree believes that although state-owned Chinese banks are among the lowest-priced areas of the global markets, they remain the largest risk in owning China based solely on market cap. As China continues to grow and transform, investors will demand more ways to gain access to this unique country. Recently, some investors have expressed concern over state-owned enterprises, and they have sought tools to limit their exposure, even after understanding the valuation differences. These investors are interested in concentrating their exposure on the private sector and accessing higher profitability potential. Although it is impossible to know which area will be more beneficial to focus on going forward, we think it is important to have different tools available, and the case for either exposure could be made, depending on an investor’s goals and objectives.         ¹Lingling Wei and Brian Spegele, “China Considering Mergers among Its Biggest State Oil Companies,” The Wall Street Journal, 2/17/15.