Some local investors looking to diversify portfolios beyond developed markets in response to high valuations and slower growth are considering emerging market exposure in the hunt for better returns.
“Developed markets have become relatively expensive,” explains James Cook from the Investec Structured Products team.
For instance, the 12-month historic price-to-earnings (P/E) ratio of the Shanghai Shenzhen CSI 300 in China is 15.8 compared to 26.5 for the S&P 500 Index. The CSI 300 price-to-book ratio of 1.6 also compares favourably to the 5.2 of the S&P.
“Moreover, portfolios heavily weighted to developed markets ignore emerging opportunities in the rest of the world, along with important portfolio diversification benefits, as exposure to the CSI 300 in a global investment portfolio has shown a 0.34-0.36 correlation to developed market indexes such as the S&P 500, Euro Stoxx 50, and FTSE 100.”
As a means to provide emerging market exposure with low correlation returns to developed markets, Investec launched International Opportunities Limited, a five-year structured investment offering simplified access to the Chinese equity market.
“An Investec analysis that considered numerous factors shows China may be an undervalued emerging market with potential for upside,” says Cook.
“When the CSI 300 fell 32.1% from its high on 10 February 2021 to 31 December 2024, it may have created an opportunity to enter into the market.”
Cook explains that COVID lockdowns, trade wars and concerns about the property market contributed to the decrease in the Chinese stock market since 2021.
“There is a possibility that investors who withdrew funds from the market may redeploy capital if sentiment turns more positive, and potential future government stimulus could act as the catalyst for this renewed interest in the stock market.”
In addition, the country possesses some strong economic metrics, with the second-largest GDP globally and a relatively low debt-to-GDP ratio. The interest servicing costs in China are also lower than in the U.S., with 10-year treasury yields at 1.65% in China compared to 4.25% in the U.S.
Over the last decade, major equity indices have experienced growth that exceeds GDP growth in their respective countries, except for China.
For example, the S&P 500 has delivered a 194% return compared to a 52% rise in U.S. GDP over a 10-year period. In comparison, GDP growth in China was 86.8% vs. 52.5% for the CSI 300 Index in US dollars (USD), according to World Bank data.
Against this backdrop, Cook says the market could see a correction in China where stock market performance starts to close the gap with GDP growth rates.
Based on these factors, the latest structured product from Investec provides exposure to the Shanghai Shenzhen CSI 300 Index, which consists of 300 of the largest and most liquid A-share company stocks in mainland China.
“The structured product simplifies market access while offering diversification, growth potential, and capital preservation benefits,” explains Cook.
International Opportunities Limited is a company that was incorporated in Guernsey to buy financial instruments that create a structured payoff profile. Investors gain exposure to the structured product payoff by purchasing shares in the company.
At the start of the investment period, the company acquires a debt instrument, an equity option, and maintains a cash reserve for fees and expenses.
The company holds these instruments until maturity, offering 100% capital preservation in USD if held until maturity, subject to the absence of any credit events by the issuer or credit reference entities1.
“The product offers a unique payoff profile, providing exposure to the growth of the index, multiplied by a participation of 130%, up to a cap of 60% over five years,” explains Cook.
“This translates to a maximum return of 78% (130% x 60%) over the term, equivalent to a maximum annualised return of 12.2% in USD.”
At maturity, investors can sell their shares or retain them and gain exposure to the subsequent structured product offering within the company.
“This reinvestment strategy allows investors to effectively “lock in” returns by setting a new capital protection level while maintaining exposure to potential future market upside,” continues Cook.
This offers a significant advantage over direct investments in the market through exchange-traded funds (ETFs).
For instance, back testing that used historical data to calculate five-year rolling returns since the Index launched in April 2005 determined that the CSI 300 5Y rolling return was negative 27.6% of the time while International Opportunities Limited would have returned 100% of investor capital during these periods.
“The geared effect also meant the simulated structured product outperformed the price-only index 86.2% of the time,” adds Cook.
According to Cook, this capital protection feature addresses a significant challenge faced by investors who may be hesitant to sell their investments in well-performing markets to realise profits. “Those that hesitate may miss out on future growth opportunities.”
With its focus on capital preservation, growth potential, and diversification benefits, International Opportunities Limited may provide an interesting investment proposition for local investors seeking exposure to the Chinese equity market.
Local investors require a minimum investment of US$10,000 and applications close on 7 March 2025.
Listen to Japie Lubbe discuss the product on this Ghost Stories podcast:
Note: the transcript for the podcast can be found here.
- The investor’s capital, in US dollars, is protected if the investment is held to maturity. Structured products provide principal protection through the assumption of credit risk. They are intended for sophisticated investors who understand and accept the risks associated. In this case, capital protection is achieved by buying credit-linked notes. Principal protection is preserved to the extent that the issuer continues to honour any outstanding obligations and the reference entities do not experience a credit event such as a default.
Disclaimer:
https://www.investec.com/en_za/legal/structured-products-disclaimer.html
