As Index Providers Change Views On China, EM ETFs Get New Looks

In an announcement made Sunday, and one that flew somewhat under the radar, Vanguard, the second-largest U.S. issuer of exchange traded funds, said the Vanguard FTSE Emerging Markets ETF VWO has started tracking a FTSE transition index as the largest emerging markets ETF by assets makes its way to a benchmark that will include China A-shares.

As Pennsylvania-based Vanguard announced earlier this year, VWO is moving to the FTSE Emerging Markets All Cap China A Inclusion Index, which as the name of that benchmark implies, will allow VWO to hold A-shares, the stocks trading on mainland exchanges in Shanghai and Shenzhen. Vanguard intends to make VWO's transition to the FTSE Emerging Markets All Cap China A Inclusion Index a gradual one.

“To minimize market impact, in the first phase, the fund will track the FTSE Emerging Markets All Cap China A Transition Index, an interim index that will gradually increase exposure to small-capitalization stocks and China A-shares while proportionately reducing exposure to other stocks based on their weightings in the new index. The transition is expected to occur over approximately 12 months and will reduce the costs associated with trading large amounts of securities in a short period,” said Vanguard in a statement. 

At the end of the third quarter, the most recent period for which data is available, VWO allocated over 27 percent of its weight to Chinese stocks with another 27.7 percent of the ETF's combined weight going to Taiwanese and Indian stocks, according to Vanguard data. 

However, investors do not need to wait for VWO's transition to be complete to see what a diversified emerging markets ETF looks like when it holds A-shares. The KraneShares FTSE Emerging Markets Plus ETF KEMP, which debuted in February, became the first U.S.-listed diversified emerging markets ETF to hold A-shares.

At the end of the third quarter, KEMP had a nearly 46 percent weight to Chinese stocks followed by a 19.8 percent weight to Indian stocks, according to KraneShares data. No other country garners a double-digit allocation in KEMP. 

News of VWO starting its transition to inclusion of A-shares comes as MSCI, the index provider for VWO's marquee rival, the iShares MSCI Emerging Markets ETF EEM, will begin adding Chinese stocks with primary listings outside of China to its international benchmarks.

Translation: Stocks such as Alibaba Group Holding Ltd. BABA and Baidu Inc. BIDU will find their way into international ETFs that track MSCI indexes.

MSCI said earlier this year it would move to include Chinese stocks with primary listings outside of China in its international benchmarks, news that some market observers see as a prelude to the index provider eventually elevating A-shares to the widely followed emerging markets index.