The American depositary receipts (ADRs) of Chinese stocks listed in the U.S. surged on Friday due to reports that Beijing intends to provide the U.S. authorities full access to the audit reports of U.S.-listed Chinese stocks.
According to the press release, a reporting framework will be put together on what data could pose a national security risk to the United States. Thus, the central aim of providing a framework would be to balance transparency and keep strategic matters undisclosed.
Why does this matter?
The likes of Alibaba (BABA, Financial), JD.com (JD, Financial) and Baidu (BIDU, Financial) are listed as American depositary receipts in the United States, meaning that they're not actual stocks but instead synthesized financial instruments that replicate their primary listings.
There's been much controversy surrounding the less strict financial reporting of Chinese ADRs, which among other matters, contributed to a massive decline in the prices of Chinese ADRs in recent years. The U.S. even passed legislation that will de-list Chinese ADRs if the companies do not comply with U.S. financial audits.
We're also in an era where ESG (Environmental, Social and Governance) matters are paramount. In addition to providing more transparency regarding financial and ESG statistics, the news that Chinese authorities have permitted their companies to share sensitive state information will give Chinese ADRs a better risk-return profile, since the real goal of the U.S. threat to de-list Chinese stocks was national security and not financials.
ADRs to look out for
The ADRs that I'd be looking out for to take advantage of this upswing are the higher-Beta ones such as Bilibili (BILI, Financial), Nio (NIO, Financial) and Huya (HUYA, Financial).
The reason why I'd opt for higher-Beta assets is because of skewness. Due to systemic support, these ADRs will likely experience negative kurtosis and positive skewness, subsequently outperforming their peers on the back of strong technical indicators.
ADRs such as those for Alibaba and JD.com will probably find robust support as well, but the issue remains that they're mature companies with less attractive short-term risk-return profiles than higher-Beta stocks.
Furthermore, Alibaba and JD.com rely on high-volume consumption, and with the Chinese PMI data looking soft, they'll likely be less prosperous than their peers who're selling more niche products.
Source: Market Radar
The bottom line
Chinese ADRs are roaring again and could reach closer to their fair values this year amid a perceived end to the financial reporting controversy. I believe higher-Beta assets will likely outperform in this situation due to skewness and niche business models.
