Sizing up China inside popular ETFs

Gargi Pal Chaudhuri May 14, 2021

Key takeaways

  • Flows into China-focused ETFs are surging as investors position for China’s growing economic and financial strength.
  • Non-Chinese investors are generally overlooking China’s growing influence on the global economy and in capital markets.
  • Exchange traded funds (ETFs) can offer efficient and cost-effective access to China’s stock market in different iterations.

China’s economy is powering up at the fastest rate in nearly a decade, and investors are turning to the world’s second-largest economy in anticipation of a surge in corporate earnings and an influx of foreign capital.1

Global investors are taking note: Flows into China-focused ETFs hit a record $14 billion in the first four months of 2021, with $3 billion from the U.S. and $5 billion coming from Europe.2

Beyond any short-term, post-pandemic rebound, the case for investing in China is becoming increasingly strategic. Many overseas investors are lightly exposed to Chinese securities, while many emerging markets-focused investors may wish to diversify away from products that will become increasingly loaded with China.

Flows into global China focused ETFs

Flows into global China focused ETFs

Markit (as of April 30, 2021).

Many global investors are China lightweights

China has been the world’s second-largest economy for more than a decade, and the country’s capital markets are second only to the U.S. in terms of size.3 Even so, non-Chinese investors own only about 3% of its domestic stocks and bonds.4

For perspective, China’s weight in the MSCI ACWI Index, a widely followed global stock benchmark, is roughly 5%, though the country’s share of global gross domestic product is nearly four times greater.5

Evolution of China’s GDP versus weight within the global equity benchmark

Evolution of China’s GDP versus weight within the global equity benchmark

Bloomberg (as of April 30, 2021)

Seeking granularity in Chinese equity markets

Owning Chinese markets is not a one-size-fits-all proposition. Historically, Beijing limited how much foreign money could be invested in Chinese companies and foreign investors were typically only able to access China with shares traded in Hong Kong (H-shares), or in the U.S. (ADRs). In recent years, shares that trade in Shanghai and Shenzhen (A-shares) have been made increasingly available to foreign investors.

Well-known companies including Alibaba Group and Tencent are listed in Hong Kong (H-Shares) or on overseas markets (ADRs), and so are represented in indexes that are designed to include many types of China shares, such as the MSCI China Index.6 In contrast, indexes comprised of China A-shares capture a larger of share of domestic companies that are more closely linked to the mainland market — less than 10% of A-shares company revenues come from exports — and represent sectors such as financials, health care and consumer staples, which were historically harder for U.S. investors to access.7

Importantly, the inclusion of Chinese A-shares into mainstream equity indexes is transforming the complexion of popular ETFs. For example, mainland China A-shares represent 4.7% of the MSCI Emerging Markets Index, compared with zero exposure before 2018; by the end of its full inclusion, the exposure could be as high as 16.2%.8

Sector weight difference between MSCI China A and MSCI China

Sector weight difference between MSCI China A and MSCI China

Source: Bloomberg (as of May 3, 2021). The MSCI China A Index captures large and mid-cap representation across China securities listed on the Shanghai and Shenzhen exchanges. The MSCI China Index captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 709 constituents, the index covers about 85% of this China equity universe.

Re-calibrating China investments

The BlackRock Investment Institute has noted that COVID-19 has supercharged the strategic competition between the U.S. and China, and also has led to a rewiring of global supply chains for greater resiliency. We believe all this means that investors may increasingly seek exposure to both markets, especially as China continues to be a bigger contributor to global growth.

For investors, the rising importance of China as well as the potential of a more bi-polar global economy supports the case for standalone positions in Chinese stocks alongside existing investments based on investment objectives.

For investors used to thinking of emerging markets as a single position, an alternative may be to carve out China separately so that its growing heft does not dilute the potential diversification benefits of broad emerging market indexes. Flows into ETFs that seek to track the MSCI Emerging Markets ex-China Index have roughly tripled total assets under management year to date as investors seem to be taking a more granular approach when making strategic allocations in emerging markets.9

Investors can look to iShares ETFs for efficient and low-cost access to China’s stock market in its different iterations.

Gargi Pal Chaudhuri

Gargi Pal Chaudhuri

Head of iShares Investment Strategy Americas at BlackRock

Jasmine Fan

Vice President