The current situation surrounding the stock prices of Chinese concept stocks appears to be in a historical low zone when viewed through a long-term lens. Investors looking toward the future may find this to be a compelling opportunity, considering that systematic investments in Chinese concept ETFs over several years could lead to favorable returns. However, the market context is undeniably challenging. Unlike the bubble burst seen in 2021, the recent downward trend in Chinese stocks, as well as Hong Kong stocks, is significantly influenced by indications of foreign capital fleeing these markets.

One of the primary factors contributing to this outflow is the escalation of conflict, specifically regarding the situation in Russia. The sanctions imposed on Russia, coupled with the suspension of its stock market and the freezing of foreign assets, have created substantial liquidity gaps in various markets. As MSCI downgraded Russia from an emerging market to a standalone market, there was a considerable impact on liquidity across emerging market index ETFs, leading to aggressive sell-offs in relatively liquid Hong Kong and Chinese concept stocks, as well as some A-shares.

Moreover, on March 10, the U.S. Securities and Exchange Commission (SEC) announced that five Chinese concept companies would be placed on a "temporary identification list." This notice requested companies like Yum China and BeiGene to provide evidence to the SEC by March 29, 2022, that they do not meet the criteria for delisting. This recurring issue, while alarming, is not entirely new. It follows established procedures set forth in a 2020 accountability law that mandates the audit firms of Chinese companies to undergo inspections by the Public Company Accounting Oversight Board (PCAOB) and make available the company's financial records.

In December 2021, the SEC formalized rules related to this accountability law. The Accounting Oversight Board designated over sixty registered Chinese accounting firms in the U.S. as unable to complete inspections or investigations, marking the law's entry into an enforcement phase. This has led to heightened scrutiny of Chinese concept stocks by the SEC. The five companies in question found themselves listed due to their timely annual reports, and as more companies release their financial disclosures, this list seems poised to grow.

The market reacted sharply to these announcements, with the KWEB (KraneShares CSI China Internet ETF) tumbling nearly 9.75% in a day. The specter of delisting has turned an already fragile market even more jittery, causing investors to reevaluate their confidence in Chinese equities.

The convergence of these factors has dramatically dampened investor sentiment toward Chinese stocks. Notably, the KWEB has even dropped below its initial offering price from a decade past. The last ten years of Chinese internet equities seem almost like a fleeting dream; however, those familiar with the market recognize that contemporary Chinese internet companies are undoubtedly more robust than their earlier counterparts. Current prices appear to offer substantial investment value based on company fundamentals.

To illustrate this point, consider Tencent, often dubbed the "king of Hong Kong stocks." By March 15, its share price fell below HKD 300, placing its market cap at USD 366.7 billion, with a price-to-earnings (P/E) ratio of just 12.66—its lowest in nearly a decade. Meanwhile, Alibaba's stock has dipped below its initial public offering (IPO) price from 2014, giving it a market cap of only USD 206.3 billion. Additionally, JD.com reported total revenues of USD 149.2 billion in 2021, which is double its current market valuation.

When assessing the factors contributing to the recent drastic declines, the first concerning the sell-off aligns with international capital's exit strategy from emerging markets, showing some signs of resolution. The second reason, involving the delisting risks for Chinese stocks, looks set to play out over time. It appears that Chinese regulatory bodies are engaged in active dialogue with their U.S. counterparts. Even if a delisting from U.S. exchanges were to occur, there remains the option for a secondary listing in Hong Kong, where several Chinese companies have already made this transition. Furthermore, Hong Kong has lowered the entry bar for secondary listings to better accommodate these companies.

Despite the prevailing pressures from anticipated interest rate hikes by the Federal Reserve that might hinder valuations in the tech sector, the current stock prices do suggest that we are looking at a bottoming phase. For investors contemplating gradual entry points through systematic investments or dollar-cost averaging in Chinese concept ETFs, the outlook for the years ahead appears promising.

In recent times, three ETFs focusing on Chinese technology stocks have emerged within the Chinese market. The first is the EFund CSI Overseas China Internet Index ETF, which tracks the performance of the China Internet 50 Index. The other two, both of which track the China Internet 30 Index, are the GF CSI Overseas China Internet 30 ETF and the Harvest CSI Overseas Internet 30 ETF. The latter two, however, are smaller in scale and exhibit higher tracking errors.

The EFund CSI Overseas Internet ETF was launched first, on January 18, 2017, while the GF CSI Overseas Internet 30 ETF only hit the market at the end of 2021. Thus far in 2022, the latter has seen a decline of 39.47%, surpassing the former's loss of 31.57%. However, the former is currently trading at a premium, with a discount rate of -9.36%, indicating that it is less advantageous for fresh investments. In contrast, the GF CSI Overseas Internet 30 ETF is priced cheaper than its net asset value by 2.75%, giving it an edge in value.

When analyzing their holdings and allocations, it's important to note that the methodologies for both the Chinese Internet 30 and 50 indices share similar sample selection criteria and rebalancing frequency, which occurs semi-annually. Both indices utilize a free float market cap-weighted approach, although differences emerge as the top weighted stocks in the China Internet 30 Index cannot exceed 15%, with the top five collectively not exceeding 60%, whereas in the China Internet 50 Index, the limitations are 30% for individual weights.

As of February 28, 2022, data from the China Securities Index Company shows that for the China Internet 30 Index, major constituents with weights exceeding 5% include: Tencent (15.88%), Alibaba (14.40%), Meituan (12.51%), JD.com (9.30%), Baidu (7.39%), NetEase (6.56%), Pinduoduo (6.35%), and Xiaomi (5.48%). For the China Internet 50 Index, the leading companies are Tencent (31.94%), Alibaba (21.19%), Meituan (12.52%), and JD.com (6.18%).

From this comparison, it's clear that the China Internet 50 Index is more concentrated, where Tencent and Alibaba combined comprise over 50% of the total weight, whereas the China Internet 30 Index displays a more diversified weight distribution.

Thus, for investors looking to concentrate on the Tencent and Alibaba combination, the EFund CSI Overseas Internet 50 ETF may be more suitable; conversely, those seeking a broader exposure to Chinese concept stocks might consider the GF CSI Overseas Internet 30 ETF as a better option.

Importantly, due to the recent sharp declines among Chinese concept stocks, some financially robust firms with adequate cash reserves may opt for privatization. Should this be approached at significantly lower valuations, the resultant losses for investors could materialize beyond just paper losses. Generally, the probability of privatization among components of the China Internet 30 Index tends to be lower, as large firms require substantial capital to undertake such maneuvers.

Finally, considering the implications of delisting risks on investments in Chinese concept ETFs, it can be anticipated that during the June rebalancing, the index provider may prioritize stocks that are publicly listed in both markets. In such cases, they may consider favoring the Hong Kong listings to mitigate the impacts of potential U.S. delistings on index ETF investments. This strategic shift aims to ensure the resilience of these investment vehicles amid ongoing market challenges.