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over the last three months chinese equities have dropped repeatedly many investors have taken advantage of this low pricing in the hopes of making long-term returns on the opposite end of the scale many investors feel that china is overly risky kathy wood is in the center of the range since she sold her chinese equities but just repurchased them using a very innovative technique this video will go into detail on the future of chinese equities and discuss all sides of the china argument for a legitimate reason chinese equities have dropped significantly new restrictions on education gaming data privacy monopolies exclusive contracts and u.s ipos have been implemented for many investors the idea that all of this has occurred in a few months is terrifying the chinese communist party can devastate chinese stocks with the flick of a finger chamat ali habitia a wealthy venture investor and spak sponsor feels that the risk associated with chinese assets is just too great to justify the investment jamaat is particularly worried about the variable interest entity vie structure utilized by chinese businesses to go public on the u.s stock exchange so what is a vie structure many individuals talk about vies but they seldom explain the risks of investing in them or how they function foreign investors are now prohibited from investing in most chinese sectors as a result chinese firms have exploited vis as a way around this limitation in the following example we will utilize alibaba to show the operation of a bie alibaba works in an industry where international investors are prohibited in other words foreign investors cannot directly hold shears in alibaba as a result alibaba must establish shell business in the cayman islands also known as alibaba but for the sake of this example we will refer to this shell firm as fake baba it should be noted that in the real world boni baba is known as alibaba alibaba will now offer fake baba contractual agreements over alibaba's income and assets after establishing fake baba this is accomplished through a complex legal procedure fake baba's contractual arrangements give it power over alibaba's debts exclusive call options proxies and equity commitments bake baba essentially holds contracts for alibaba's income and assets but does not own the stock alibaba will now list phony baba on the new york stock exchange allowing u.s investors to invest in it alibaba can circumvent chinese regulations prohibiting foreign ownership by employing this method alibaba isn't truly going public on the new york stock exchange because phony baba is on the opposite side of the deal u.s investors do not own shares in alibaba directly only u.s investors possess stock in fictitious baba this structure is called as the variable interest entity structure or vie structure for short the vi structure is used by most chinese firms to go public on the u.s stock exchange bies have served their purpose effectively for many years however there are some serious issues with the structure to begin with the bie structure is legally unlawful because it is simply a loophole that allows foreign investors to acquire stock in china as a result china may declare vis illegal at any time jamaat feels that investing in china is a risk that should be avoided due to the vie structure many investors on the other hand think that the potential rewards in chinese equities outweigh the dangers what's noteworthy is that many value and growth investors regard china as having promise kathy wood ceo and founder of arc invest recently re-entered their chinese holdings after selling them a few months earlier many investors who had been following kathy were taken aback especially because kathy had earlier stated that chinese new restrictions were undermining capitalistic incentives nonetheless instead of investing in all chinese businesses that have disrupted potential she is now handling the problem in a very unusual way kathy is currently investing in chinese firms with government assistance especially jd.com and pin duo duo while selling alibaba and baidu the ccp's new rules were highly anti-alibaba which benefited jd and pin duo duo indirectly indeed during jd's last quarterly conference call jd retail ceo shulay made a dig at alibaba according to shulay chinese new laws are intended to curb misbehavior such as chaotic capital development and monopolistic relationships these objectives are beneficial to jd's long-term business growth alibaba's unprecedented anti-trust punishment 2.8 billion dollars was alluded to in the late statement this penalty was imposed when officials discovered that alibaba was entering into exclusive arrangements with brands that prohibited them from selling items on jd.com this record fine is directed against alibaba as a result kathy wood only invests in chinese firms that are government-backed kathy wood exclusively invests in chinese firms that have high government backing although many value investors do the reverse data roma a website records the holdings of all great investors including charlie munger bill gates bill ackman manish prabrai and many others these investors have outperformed the market in the long run and are typically worth considering alibaba was the top buy for all super investors in the second quarter of 2021.
monish purbride guy spire and bill miller are among the successful long-term investors that acquired alibaba in the first quarter of 2021 warren buffett's right-hand man charlie munger acquired alibaba stock which is remarkable considering that he has openly spoken out against the vie structure so considering the dangers associated with the vie structure why do monger and others continue to buy alibaba according to one charles schwab employee if china delists chinese equities investors in china will not lose all of their money first and foremost in the event of a delisting chinese stock investors would retain their holdings in chinese equities the only issue is that those investors will need to find a way to exchange them as the vie contracts will still theoretically have value investors will be able to trade their chinese stocks over the counter or swap their shares for hong kong shares in the united states one share of alibaba may be exchanged for eight shares of alibaba in hong kong as a result if alibaba is de-listed in the united states charles schwab will assist its clients in transferring their alibaba shares to hong kong shares where they will retain some value the second alternative would be to trade those alibaba shares over the counter in the united states in any case those alibaba shares would retain their worth keep in mind that this isn't the worst case scenario for chinese stocks being delisted many investors feel that the nuclear option of a d-listing would never materialize this is because delisting chinese equities would trigger world war three aside from the delisting risk a lot of chinese firms are fundamentally solid therefore you should be more concerned about survival in your portfolio as a whole if world war iii breaks out even monish prabrai a hedge fund manager who has allegedly averaged a return of 25.7 per year over the last 18 years feels that alibaba's fundamentals are stronger than those of the top tech companies in the united states monish has committed almost 20 of his portfolio to alibaba thus this is a significant investment for him with that stated there are some major dangers to investing in chinese equities and no one knows what laws are on the way except the chinese government charlie munger argues that china is not motivated to destroy its own industries therefore any laws are unlikely to have a substantial influence on the fundamentals of chinese enterprises monger has put his money where his mouth is allocating around 17 percent of his portfolio to alibaba so if you're willing to take the risk of investing in china go ahead chinese equities have the potential to deliver enormous returns and they are now trading at a massive discount which although somewhat justified is likely an overreaction let me know what you think in the comments below if you think it's worth investing in chinese stocks
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