The rise of China's shadow banking system and increased concerns about non-performing loans in the world's second-largest have prompted some global investors to be skittish about Chinese bank stocks.
Although it is fair to say emerging markets financial services firms are riskier than their U.S. equivalents, rising dividends could be one reason investors should consider exposure to Chinese banks.
In addition to the rising dividends, the major Chinese banks recently offered up some pleasant surprises in the terms of their year-end profits for 2012.
"Many of the largest Chinese banks recently released their year-end earnings reports for 2012. What might be surprising to some is that the reports came out better than many analysts had expected," said WisdomTree Research Director Jeremy Schwartz in a new research note.
Of the three major Chinese banks, all three "reported an increase in net profits of more than 10% compared to the previous year," said Schwartz in the note.
For example, China Construction Bank's net profit jumped 14.26 percent last year from 2011. Industrial and Commercial Bank of China posted a net profit increase of 14.5 percent while Bank of China's after-tax profit climbed 11.51 percent. Schwartz also noted the return on equity for the big three China banks was superior to some developed market peers.
The average return on equity for the aforementioned Chinese banking giants in 2012 was nearly 21 percent. By comparison, J.P. Morgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) had an average return on equity of just under 12 percent, according to WisdomTree data.
One ETF that could benefit from a more positive outlook surrounding Chinese banks is the WisdomTree Emerging Markets Equity Income Fund (NYSE:DEM). As is the case with many diversified emerging markets ETFs, DEM has a large weight (27.8 percent) to the financial services sector. However, a significant portion of that allocation goes to major Chinese banks.
China Construction Bank is DEM's largest holding with a weight of nearly 8.2 percent. Industrial and Commercial Bank and Bank of China are DEM's fifth- and seventh-largest holdings, respectively, combing for nearly five percent of the ETF's weight.
The WisdomTree Emerging Markets Equity Income Index (WTEMHY) weighs constituents based on annual cash dividends paid, according to the issuer. That means Chinese banks could take on an increasingly important role in terms of driving DEM's performance.
"The increased dividends and profitability have contributed to generating positive stock price performance since these companies were added to the WisdomTree Emerging Markets Equity Income Index," said Schwartz in the note.
Recently, the large Chinese banks have delivered some impressive dividend increases. China Construction raised its payout 16.2 percent while Industrial and Commercial boosted its dividend more than 20 percent. Bank of China raised its dividend 15.6 percent.
"Since being added to the Index, these companies have grown both their profits and their dividends, and their share prices have reacted positively as a result," said Schwartz.
Investors looking for a more concentrated bet on Chinese banks can consider the Global X China Financials ETF (NYSE:CHIX). Bank of China, China Construction and Industrial and Commercial combine for about 30 percent of that ETF's weight.
CHIX is small with just $7.33 million in assets, but the fund does have a solid return on equity of just over 15 percent. This ETF, however, arguably embodies the volatility associated with emerging markets bank shares. CHIX has a beta of 1.19 against the MSCI Emerging Markets Index and a three-year standard deviation of almost 33 percent, according to Global X data.
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