China ETFs Assert Some Leadership

Diversified emerging markets exchange-traded funds delivered solid performances last year, a fact made all the more impressive when considering Chinese equities lagged. China is often the largest country weight by a wide margin in broad emerging markets ETFs.

2016 Performances

In 2016, the widely followed MSCI Emerging Markets Index rose nearly 11 percent while the iShares China Large-Cap ETF FXI gained just 1.1 percent. The iShares MSCI China Index Fund MCHI lost a third of a percent. With those slack showings in mind, it is indeed impressive the MSCI Emerging Markets Index performed as well as it did with a weight of over 26 percent to Chinese equities.

Investor Hesitations: Debt And The Donald

There have been reasons to discourage investors from nibbling at ETFs such as FXI and MCHI. China's debt burden is increasing and there is a specter of a trade war with the United States now that Donald Trump is President Trump. Additionally, foreign investors have been pulling money from equity markets in the world's second-largest economy.

Related Link: An ETF For China's Internet Celebrities

“Companies have enjoyed solid earnings growth, but high levels of investment have left little to distribute to shareholders. China H-shares — listed on foreign exchanges such as Hong Kong — have fared better than A-shares—listed on onshore exchanges,” said BlackRock in a recent note.

FXI And MCHI Profiles

FXI, the largest China ETF trading in New York, holds 51 Chinese large caps with Hong Kong listings and some of the ETF's member firms also trade in the United States. The ETF is up 11 percent year-to-date. MCHI is another large China ETF and its roster is about triple the size of FXI's. That ETF is higher by 12.2 percent this year.

“‘Old economy’ sectors such as materials, industrials and financials are still overrepresented in the domestic A-share market, but ‘new economy’ companies in consumption-driven sectors such as technology and services accounted for half of the IPOs in the A-share market in 2016, we calculate,” said BlackRock.

MCHI allocates 32.5 percent of its weight to technology stocks, more than triple the weight FXI assigns to that sector. MCHI has a 30.1 percent weight to financial services stocks, but that is dwarfed by the more than 49 percent FXI devotes to that sector.

As measured by FXI or MCHI, Chinese stocks are inexpensive. Those ETFs sport an average price-to-earnings ratio of around 10, implying discounts to the MSCI Emerging Markets Index and the S&P 500.

“We see Chinese stocks supported by an accommodative and flexible policy that aims to stabilize growth ahead of the 19th Party Congress this fall. The near-term upside may be capped by trade tensions and the pace of structural reforms. There is also China’s ever-growing debt pile to monitor. But over the medium term, we believe Chinese equities are an attractive, and under-owned, asset,” said BlackRock.