China ETFs Scrambling For Support

Emerging markets stocks and exchange-traded funds are thought to be strong performers this year, but the reality is the MSCI Emerging Markets Index is down 0.1 percent. Still, that is better than what investors became accustomed to diversified emerging markets benchmarks over the past few years.

Weakness In China

Arguably, that is a sturdy showing from the widely followed MSCI Emerging Markets Index considering how poorly Chinese stocks, both A-shares and Hong Kong-listed fare, are performing this year. The iShares FTSE/Xinhua China 25 Index (ETF) FXI, the largest China ETF trading in New York, is down 10.5 percent year-to-date.

Further underscoring weakness in Hang Seng-listed stocks, the iShares MSCI Hong Kong Index Fund (ETF) EWH is down 4.6 percent. Things are worse on the mainland where the Shanghai Composite is in the midst of a five-week losing streak, adding to the Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF ASHR year-to-date loss of 17.7 percent.

Related Link: What Negative Rates Are Doing To Financial Services ETFs

Investors Shying Away

At the moment, it appears as though international investors are taking the same view as the locals, which is to stay away from Chinese stocks.

“Looking at the ETF most widely used by Western investors (FXI) and the one widely traded in Hong Kong (HK: 2823), which track the same markets, it is clear that, just like the locals, no offshore investor either is currently involved in the Chinese equity markets,” said Rareview Macro founder Neil Azous in a note out Monday.

Data support the notion that China ETFs are trees falling in a forest with no one around to hear those falls. For example, investors have pulled nearly $1.5 billion from FXI this year, dropping that ETF's assets under management tally to $3.3 billion. EWH came into the year with about $2.2 billion in assets, but that number has since been slashed to $1.5 billion.

Increasing Concerns

Increasing concerns that bad debt will hinder the Chinese economy are plaguing the aforementioned ETFs and others because many China ETFs are heavily allocated to the country's big banks. Bad debt equals non-performing loans and that is a toxic brew for ETFs that devote a third or half their weights to the financial services sector.

Another issue is that Beijing has swallowed massive percentages of China's big banks, potentially removing a big buyer of these shares from the market, at least in the near term.

“BAML recently counted that after buying relentlessly for the last six months China now owns 50 percent of the float of the Big 4 banks. As a reminder, the sector allocation to financials in each of these benchmarks or ETF’s is 20–30 percent with the Big 4 banks making up the majority. Put another way, there is now an implicit floor in the bank sector,” added Azous.