ETF Trends
ETF Trends

The popular developing-country-focused exchange traded fund, Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO), has switched to a new benchmark index that will gradually shift component holdings to include Chinese A-shares.

As of November 2, VWO will begin tracking the new FTSE transition index that will begin building exposure to small-capitalization stocks and China A-shares before finalizing the switch to the FTSE Emerging Markets All Cap China A Inclusion Index, according to Vanguard Group.

VWO will follow a transition index for approximately one year to diminish costs associated with the huge amount of securities that will need to be acquired. Specifically, the fund will sell large- and mid-cap stocks on a monthly basis while proportionally adding China A-shares and small-cap ex China A-shares.

The Vanguard Emerging Market ETF is a behemoth with $37.5 billion in assets under management, so any large reallocations could affect underlying prices.

As of September 30, the FTSE Emerging Markets All Cap China A Inclusion Index held 1,856 small-cap companies, or 11.3% of the index, and 1,454 Chinese A-shares, or 5.8% of the index.

“The initial weighting of China A Shares in the FTSE Emerging inclusion indexes will be approximately 5%. This is expected to increase to 32% (at 31-March 2015 market values) when China A Shares are fully available to international investors, and hence resulting in Chinese stocks (including B-Share, H-Share, P Chips and Red Chips) to make up 50% of FTSE Emerging Index,” FTSE Russell previously said in statement.

Through the changes, VWO will be the first broad market-cap-weighted index fund to include both all-cap exposure and China A-shares as the ETF moves toward a more inclusive market-cap weighted methodology. While current index-based emerging market funds include a heavy tilt toward China, most offerings only track Chinese H-shares that are listed in Hong Kong or Chinese companies listed in the U.S. Consequently, with the inclusion of Chinese A-shares, China’s domestic markets may play a more direct role in investors’ portfolios.

“As the first major emerging markets fund to add exposure to China A-shares, the fund will benefit investors with more diversification, deeper emerging markets exposure, and greater access to the growth potential of Chinese equities,” Vanguard CEO Bill McNabb said in a press release.

In contrast, the iShares MSCI Emerging Markets ETF (NYSEArca: EEM), which tracks an MSCI index, has stated not moved to add China A-shares to the benchmark MSCI Emerging Markets Index, but MSCI has hinted that it will move to include Chinese mainland stocks.

Another big difference between EEM and VWO is South Korea. FTSE Russell considers Asia’s fourth-largest economy a developed market while MSCI sees it as an emerging economy. In fact, MSCI has pulled South Korea from the list of candidates for a potential promotion to developed markets status. EEM allocates over 16% of its weight to South Korea while VWO has no exposure to the country.

For more information on ETF index methodologies, visit our indexing category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.