Jason Hsu, Rayliant Global Advisors - As Investors, We’re Always Looking For Uncorrelated Sources Of Return | #296

Episode Summary

Executive Summary: Jason Hsu argues that Chinese A-shares offer a distinct, underexplored source of alpha and diversification because China’s market structure, regulation, and retail-dominated trading behavior differ sharply from the U.S. He explains how Rayliant’s active ETF uses quantitative signals like management integrity, retail ownership, and safety to exploit inefficiencies while addressing concerns around accounting, state-owned enterprises, and China’s policy risk.

Main Topics: China vs. U.S. market structure and regulation (Priority: 5/5): Hsu contrasts Chinese regulators with U.S. regulators, framing China as more paternalistic and interventionist, with exchanges acting like gatekeepers and investigators that heavily police listings and disclosures. A-shares as an alpha opportunity (Priority: 5/5): He argues onshore Chinese A-shares are more retail-driven, less efficient, and therefore richer in mispricing than offshore Chinese stocks or U.S. markets, making them attractive for active quant strategies. Portfolio construction of the Rayliant China ETF (Priority: 4/5): The ETF starts with a liquid universe, narrows to about 800 high-liquidity names, then to roughly 100 holdings using quantitative factors emphasizing value, quality, integrity, and safety, with broad diversification. Accounting quality, integrity, and forensic analysis (Priority: 5/5): Hsu says Chinese firms often smooth earnings to avoid negative reported numbers because of regulatory pressure, so his models adjust accounting data and include management integrity metrics. State-owned enterprises and policy effects (Priority: 4/5): He rejects blanket exclusion of SOEs, arguing performance differs materially between local political SOEs and centrally controlled SOEs tied to Beijing, with the latter often benefiting from national policy support. Valuation, sector dispersion, and growth/value dynamics (Priority: 4/5): He says China is not expensive in aggregate, but cross-sectional dispersion is extreme, with cheap banks and very expensive speculative tech names; his strategy avoids the most frothy growth areas. Foreign allocation, EM benchmarks, and currency views (Priority: 4/5): Hsu tells advisors that China is not the problem inside EM, that MSCI indices still overweight lower-quality offshore China, and that renminbi exposure should generally be unhedged given long-term currency strength expectations.

Key Arguments: China should be viewed through a different lens than the U.S.; its regulators are more paternalistic and exchanges police companies aggressively, which changes how markets function. Onshore A-shares are the real source of opportunity because they are more retail-driven, less efficient, and offer better access to China’s growth than offshore ADRs or Hong Kong listings. Quantitative factors like value, quality, and forensic accounting still work in China because the market is less crowded by sophisticated investors. Management integrity matters more in China because reported accounting data can be distorted by earnings smoothing and regulatory incentives to avoid losses. Not all state-owned enterprises are equal; centrally controlled SOEs can outperform while regionally controlled SOEs often underperform due to local political incentives. China is not expensive on median valuation, but the market has huge dispersion, so investors should avoid speculative, narrative-driven names and focus on more sensible quality/value opportunities. China’s inclusion in EM indices is increasing, especially for A-shares, which may draw more passive flows and reduce the sense of being an early or isolated investor. Unhedged renminbi exposure is preferable because hedging costs can be meaningful and China’s long-term economic ascent may support currency appreciation.

Data Points: Assets gathered across ETFs in Asia and China: about $2 billion - Hsu says Rayliant built its Asia/onshore China presence and accumulated this amount across five ETFs. Number of ETFs launched in China and Hong Kong: 5 - The firm launched multiple products in Asia before bringing a strategy to the U.S. Growth vs. value performance in China last year: growth outperformed value by 35% - Used to illustrate extreme style volatility and rapid erosion of any expected value premium. Retail share of onshore Chinese trading: 85% to 90% retail traded - Hsu describes A-shares as a retail-dominated market versus institutional offshore markets. Liquidly traded Chinese stocks in key indexes: roughly 3,800 - Approximate number of liquid Chinese names across large and small caps. Liquidly traded U.S. stocks in key markets: about 3,200 - He compares China’s market breadth with the shrinking public U.S. market. U.S. historical public-stock count: close to 5,000 - He notes the U.S. had more listed companies in the past before privatization and concentration. Typical retail investor portfolio turnover in China: a couple hundred percent a month - He characterizes average retail behavior as aggressive, short-term trading. Typical retail investor holdings in China: 4 to 6 stocks - He uses this to illustrate concentrated, speculative behavior. Retail underperformance vs. market: closer to 12% to 14% - He says retail investors underperform the market by this margin in China, much more than in the U.S. China A share inclusion in MSCI Acqui index: 0.4% - Current weight cited as very small, implying room for growth in benchmark inclusion. China A share inclusion in MSCI EM index: about 4% - Current inclusion remains limited relative to China’s economic significance. Expected increase in MSCI China A inclusion: 5x over time - Hsu expects benchmark inclusion of A-shares to rise substantially. China corporate earnings growth (15 years): 14% year-over-year - He cites this as much stronger than U.S. corporate earnings growth. U.S. corporate earnings growth (15 years): just over 5% year-over-year - Used as a comparison to highlight China’s faster growth. EM ex-China EPS growth: 2.5% nominal - He says EM performance looks far weaker once China is removed. China ETF return cited for small-cap strategy: 98.5% return - He says their China small-cap growth product was among the best-performing China ETFs globally last year. China Tesla reference company market cap movement: from penny stock to $60 billion - Hsu cites NIO as an example of extreme valuation expansion and speculative risk. NIO losses per car sold: $44 per share for every car sold / about $100,000 - He uses this to illustrate how stretched and unprofitable the company was despite its market cap. State-backed SOE performance difference: 2% to 3% better than the rest of the market - He claims centrally controlled SOEs often outperform by this amount. Regional SOE underperformance: 5% to 6% behind the market - He says locally controlled SOEs tend to lag materially. Currency hedging cost to USD: 3% - He argues hedging renminbi exposure into dollars can consume yield. China’s sovereign credit yield advantage: 3% additional yield - He suggests Chinese sovereign credit can offer a meaningful spread over U.S. bonds.

Pivotal Quotes: "you really want to think of Chinese regulators versus US regulators as kind of the tiger mom versus Montessori" — Jason Hsu: He explains the fundamental difference in regulatory culture and market supervision. "the retail underpinning performance versus the market... in China, it's closer to like 12, maybe 14 percent" — Jason Hsu: He describes how Chinese retail investors underperform due to return chasing and short-term trading. "China is not what's driving that problem. China is actually unique and it's like the savior for the EM portfolio." — Jason Hsu: He responds to advisors who dismiss emerging markets because of poor overall performance.

Implications: For investors, the episode suggests China A-shares may offer genuine diversification and alpha if approached with active, data-driven methods. The main edge comes from understanding local market structure, accounting quirks, and policy dynamics rather than using a generic EM lens.