Emerging market exchange traded funds provide diversified exposure to the developing economies, but most broad picks are leaving opportunities on the table as many options do not include domestic China A-shares exposure.
“For the Chinese economy to be fully represented in global indexes and portfolios, A-share inclusion is critical, and our analysis has hinted at industries that are likely to grow as China’s demographics change,” Mat Lystra, senior research analyst for FTSE Russell, said in a note.
Lystra pointed out that the majority of China’s economy as represented by domestic A-shares class is still heavily restricted for foreign investment, which leaves most global indices and portfolios with an incomplete exposure to the Chinese equity markets.
For instance, while many of the popular emerging market funds include China exposure as one of their top country holdings, most funds access Chinese companies through H-shares or Hong Kong-listed stocks or N-Shares that are traded on the New York Stock Exchange. However, despite sharing a country of origin, the share class does not move in lockstep with Chinese domestic markets.
According to FTSE Russell data, A-shares exhibits a weak 0.62 correlation to H-shares and an even weaker 0.30 correlation to the Russell 3000.
“For now, A-shares offer diversification for developed market-oriented portfolios, but this is likely to change as A-shares are increasingly brought in to global portfolios,” Lystra said.
Fueling the divergence in correlation between the various share classes, H-shares have a heavy tilt toward the financial sector as most Chinese banks and insurance companies tend to list on the Hong Kong Exchange to access international capital.
Meanwhile, the share class that represents the largest portion of the Chinese economy is the A-shares class, which comprises over two thirds of the total Chinese equity market.
To help remedy investors’ underexposure to China’s domestic equities, the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO), which tracks the FTSE Emerging Markets All Cap China A Inclusion Index, was the first broad market-cap-weighted index fund to include both all-cap exposure and China A-shares.
China currently makes up 28.0% of VWO’s underlying portfolio. When FTSE initially added China A-shares to its emerging market benchmark, A-shares made up approximately 5% of the portfolio and was expected to eventually make up 50% of the FTSE Emerging Index once A-shares were fully available to international investors.
Alternatively, investors can also gain direct exposure to A-shares through ETF options that track China’s benchmarks. For example, the CSI 300 Index serves as the underlying benchmark for the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (NYSEArca: ASHR), the largest U.S-listed A-shares ETF, and the Market Vectors ChinaAMC A-Share ETF (NYSEArca: PEK), the oldest A-shares ETF trading in the U.S.
For more information on the Chinese markets, visit our China category.