Don't Give Up On China ETFs Just Yet

That is an admittedly tough proclamation to make when China exchange-traded funds are obvious laggards in the emerging markets space this year. The iShares FTSE/Xinhua China 25 Index (ETF) FXI, the largest China ETF trading in the United States, is down 7 percent year-to-date, while the widely followed MSCI Emerging Markets Index is higher by 2.8 percent.

Another Perspective

However, with pessimism regarding Chinese equities, the economy there running high and with it being all too easy to be bearish on Chinese stocks, the time could be right for an alternative point of view. That would mean overlooking China's debt woes, but that is an issue meriting of further examination.

Related Link: China ETFs Scrambling For Support

“First, consider who owns the debt. During the Mexico debt crisis in 1994, the Asian debt crisis in 1997 or the Brazil crisis in 2002, foreign investors were the dominant stakeholder. In contrast, according to UBS, more than 90 percent of Chinese debt is currently domestically owned,” according to BlackRock.

Foreign Holders Of Chinese Debt And National Savings Rate

In other words, foreign holders of Chinese debt would likely not trigger a market negative event by selling those investments for the simple reason that they do not own enough Chinese debt in the first place. As BlackRock data indicate, a drag on Chinese stocks is the country's high savings rate, indicating that many local investors prefer asset classes other than their domestic equities.

“The national savings rate may in fact justify the high debt level, as some have argued, with Chinese savings matched to debt issuance. Case in point: China’s gross savings rate has been high for decades, averaging around 45 percent of GDP for the last 20 years, per the World Bank,” noted BlackRock.

Foreign investors are equally, if not more, squeamish about Chinese stocks as highlighted by nearly $1.5 billion in outflows from FXI this year. Departures from FXI can also be seen as a sign of foreign investors' reluctance to be bullish on Chinese banks because financial services stocks account for over 52 percent of that ETF's weight.

Proactive Beijing

Another glimmer of hope for FXI and rival China ETFs stems from the fact that Beijing is often proactive in at least attempting right China's economic ship when it is adrift.

“Reforms need to be implemented to support the country’s long-term growth potential. The goal is to transition the economy to a more sustainable and stable path based around consumption rather than investment,” added BlackRock.