[This article appears in our August 2018 issue of ETF Report.]
With China comprising 30% of the MSCI Emerging Markets Index, and soon to take up 40% once all the mainland Chinese stocks are added (known as A-shares), the Asian nation will dominate the index.
Since some of the biggest emerging market exchange-traded funds—like the iShares Core MSCI Emerging Markets ETF (IEMG), with $46.7 billion in assets under management (AUM), and the iShares MSCI Emerging Markets ETF (EEM), with $31 billion in in AUM—follow the MSCI index, that can significantly tilt portfolios toward China.
EEM Country Breakdown
Emerging market asset allocation in portfolios is usually small, so having one nation dominate the makeup of a popular index may adversely affect returns. Some financial advisors may want to consider ways to offset China’s influence, whether as a strategic or tactical decision.
There are a few ways to blunt the impact China has on emerging market asset allocation: by using the few ETFs that specifically exclude China, using an equal-weight ETF like the Invesco MSCI Emerging Markets Equal Country Weight ETF (EWEM) or using single-country ETFs.
Alternatives To The Traditional
The downside of using the equal-weight or ex-China ETFs is they have low AUM, says Rick Wedell, chief investment officer at RFG Advisory. EWEM has $12.6 million in AUM, the iShares MSCI Emerging Markets ex-China ETF (EMXC) has $9.6 million and the Columbia EM Core ex-China ETF (XCEM) has $8.7.
EMXC Country Breakdown
When choosing a single-country ETF to offset Chinese exposure, Wedell says it takes time to go through the different countries because “each one of them has its own nuanced behavior.”
Several ETF experts say advisors should think about the role a single-country emerging market ETF will play in the portfolio. Is it a commodities producer, demographics-driven, technology-focused, a country with a similar profile as China, or the opposite? Since emerging markets aren’t a monolithic region, advisors need to consider all of these factors.
“They’re quite different. If you look at South Korea or Taiwan, they’re exporting countries, while India is more like an importing country. Especially now with the different … trade wars and everything that’s happening right now, it really matters where you put your bet,” said Dina Ting, senior portfolio manager for global ETFs at Franklin Templeton, which offers single-country ETFs.
Chris Dhanraj, head of ETF investment strategy for iShares, says exchange-traded product flows this year at iShares suggest investors are looking to diversify out of the broad emerging market ETPs. In the past three months (as of June), there was $5.9 billion in U.S. ETP outflows from the broad emerging market products, and some of that is likely tied to worries about China as tensions about possible trade wars with the U.S. rise, he says.