As China Opens, ETFs Open Up Your Investing Options

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We can all agree that Russia was the country in 2002 that provided the largest amount of political and regional volatility. From an economic perspective, however, that title would have to go to China.

The steps China’s government took to control the spread of Covid make what the U.S. and other countries went through in 2020 trivial by comparison. Whether welding citizens’ homes shut or deploying what came to be known as “The Big Whites” to disperse crowds or otherwise enforce lockdown rules, China went out of its way to try and contain Covid in 2022. The result of this position on the global economy was devastating. It is estimated that in 2018, China accounted for 28% of global manufacturing output, and 32% in 2020. The year 2021 saw this number drop slightly to 30%. It is now obvious that the country’s Zero-Covid policies drove the near record drop in gross domestic product growth in 2022, eclipsed only by 2020’s 2.2% GDP figure and the 1.6% contraction in 1976 after the death of then leader Mao Zedong. Expectations are that the country’s share of global manufacturing suffered a similar downturn, especially given the number of companies that began to explore onshoring manufacturing away from China.

OK, that’s the bad old news. The good news from an economic perspective is that China recently decided to abandon its draconian approach to managing the Covid pandemic. While this means increased infection rates and renewed pressures on health care infrastructure, it also means that China Inc. is once again open for business. The good news for ETF investors is that there are a bunch of funds that provide exposure to China. As you may know, while most markets have a single type of common equity share class, China has, well, more. Shares listed on the in country Shanghai Stock Exchange or the Shenzhen Stock Exchange are considered local shares and are identified as either “A” (quoted in RMB) or “B” (quoted in USD or HKD) shares. Chinese company shares listed in Hong Kong are referred to as “H” shares. “N” shares refer to shares listed in non-Chinese exchanges, like the NYSE or Nasdaq (think Ali Baba (BABA) ). I mention this because China-focused ETFs can also break down along these lines.

A-Share Exposure or B-, H- and N-?

Chinese equity shares that are made available to foreign investors include B, H, and N and can be accessed through normal channels. B-Shares are available through a Hong Kong based access program. Getting access to A-Shares involves participating in a Qualified Foreign Institutional Investor (QFII) process. I was part of the team that brought Morgan Stanley’s China A Share Fund (CAF)  to market back in 2006 and I can tell you the process is not for the faint of heart.

A-Shares are often touted as providing access to the full scope of the Chinese economy simply because only a subset of Chinese companies are offered through the other share classes. As an example of this, here are two tables showing ETFs that provide A-Share access and funds that stick to the other external shares.

Source: Factset, All You Can ETF

And the external share exposure funds:

Source: Factset, All You Can ETF

As you can see, the results from the past year through Jan. 13 tell a different story for each group. Depending on your point of view, getting exposure to China now might mean sticking to the offshore shares to capture the more robust companies with global exposure, or it could mean jumping into the local share market, where, theoretically, you can find better deals. If your theory is mean-reversion based, then perhaps the A-Share focused funds might be worth looking into. While the global economy is expected to have a tough year, some are calling for China to make up a lot of ground now that Covid restrictions have been lifted.

If you want China exposure but want to also maintain broad emerging markets representation, a basic Europe, Australasia, and Far East tracking fund like the iShares MSCI Emerging Markets ETF (EEM)  has a roughly 33% allocation to China, so you can maintain emerging market exposure, but get an overweight position in China. Conversely, if you want to avoid China altogether, there are always funds like one I’ve written about before, the Freedom 100 Emerging Markets ETF (FRDM) .

The bottom line for a lot of investors is that China represents a relative opportunity within the emerging markets space. The flexibility of the ETF structure gives you several ways to either sidestep the opportunity or play it as you see fit.