After the United Kingdom referendum vote, market observers are eyeing China as the next potential trouble spot. Emerging market investors who are wary of further weakness in China can look to a broad exchange traded fund that specifically excludes Chinese market exposure.
Albert Edwards of the Societe Generale Group argued that the stealth renminbi (RMB) devaluation represents a greater danger for the worldwide economy than the Brexit vote, writes Chase Carmichael for Investopedia.
The Chinese trade-weighted currency basket has depreciated 10% since August 2015 and continues to weaken despite a stabilizing RMB to U.S. dollar exchange rate. Observers have warned that a weakening RMB may reflect weakness in the China, the second largest economy in the world.
[related_stories]China has also been accumulating greater debt to expand accommodative measures as a way to support its economy. However, Beijing may have been fueling bad credit through lax regulation and cheap lending. Consequently, at the end of 2015, China’s total private and public debt was around 350% of GDP, well above the 250% to 350% range that studies attribute to diminished economic growth.
After the spending spree, China may be bogged down by high debt inefficiency. Since 2014, the income generated from 97.5% of municipal bonds have gone to paying outstanding debt obligations. About 44% of corporate debt issued in 2015 went back to repaying obligations.
Related: A New Emerging Market ETF for Those Wary of Volatile China
As of June 2016, China’s had a 1.7% ratio of nonperforming loans, and McKinsey & Company’s credit analysis projects the ratio to rise to 15% in 2019 if China continues down its current path. Moreover, McKinsey & Company calculated that the cost of handling bad debt could increase from 1 trillion yuan to 3 trillion yuan every year.
Given the risks that China faces, emerging market ETF investors can look to the EGShares EM Core ex-China ETF (NYSEArca: XCEM) as a way to tap into developing country growth without being exposed to Chinese equities. XCEM is up 14.9% year-to-date.
XCEM tries to reflect the performance of the EGAI Emerging Markets ex-China Index, which tracks up to 700 emerging market companies, excluding those domiciled in China and Hong Kong. Top country weights include South Korea 18.7%, Taiwan 13.9%, India 13.1%, Brazil 13.1% and South Africa 10.4%.
Related: Emerging Markets ETFs Could be in for Lengthy Rallies
In contrast, other emerging market equity ETFs include a large tilt toward China, and China’s exposure within major emerging market benchmarks is growing as indexers plan to increase weights to China through A-shares.
For instance, the iShares MSCI Emerging Markets ETF (NYSEArca: EEM), which tracks the widely observed MSCI Emerging Markets Index, includes a 25.2% tilt toward China, followed by 14.5% South Korea, 12.2% Taiwan, 8.4% India and 7.3% Brazil. MSCI has yet to pull the trigger on including Chinese A-shares into its index.
“The XCEM fund is a strong fit for investors who are looking to be more conservative in their approach to China without sacrificing opportunities in other emerging markets,” EGA Managing Director Jay McAndrew said. “It also addresses the needs of investors who have a point of view on China and are looking for greater control over the size and style of their exposure to this market.”
EGShares EM Core ex-China ETF