Rethinking China

[This article appears in our October 2020 issue of ETF Report.]

Pulling this issue of ETF Report together, one thing stood out to me: China is inextricably linked—if not synonymous, as Lara Crigger’s article notes—with emerging markets. It positively dominates the category, representing  (along with Hong Kong) well over one-third the weight of any given broad emerging market ETF. And maybe that needs to change.

For the past 20 years or so, China has been a unique growth story, stunning investors with its rapid expansion and the opening of its markets.

After reaching incredible economic success, it’s now the second-largest economy in the world, with the largest population of any country, at 1.4 billion. That doesn’t sound like an emerging market, or even a developing one, if you want to get picky with terminology. China has arrived.

So why is it still so strongly associated with emerging markets, an asset class whose very name implies an economy in its early stages?

Authoritarian State

Further, China is not a democracy. You can’t really even call it a genuine communist state, despite it being led by the Chinese Communist Party. Almost every sizable market in the world is at least technically a democracy.

China’s government is not considered trustworthy either, not by its citizens and not by the wider world. It’s long been suspected that its leaders can be manipulative with financial data. And with the rise of environmental, social and governance strategies, its authoritarian government opens up another can of worms for investors.

China essentially operates with its own set of rules, so that alone could be an argument for making it its own asset class.

But consider the international sector ETFs targeting single markets. For China, there are U.S.-listed ETFs covering all the key sectors and some themes in China’s markets—16 in all. There’s even an ETF issuer (KraneShares) largely devoted to providing ETFs with different angles on China’s market.

What about other countries? India is represented by one consumer-focused ETF, while Israel is the focus of two technology funds. That’s about it.

Its Own Category

We treat the U.S. as a separate market from the rest of the world. It is, of course, the home country for U.S. investors, but in a globalized world, that doesn’t matter so much. What really makes a focused and granular allocation make sense is the fact that it’s the largest economy in the world.

China’s sheer economic size despite being classified as an emerging market also suggests it’s a special case.

Pulling China out of broad emerging market indexes and making it its own category will also give smaller emerging markets a chance to shine. The top three countries in the iShares MSCI Emerging Markets ex China ETF (EMXC) are Taiwan, South Korea and India, and their weights are nearly double what they are in the China-inclusive iShares Core MSCI Emerging Markets ETF (IEMG).

Currently, China dwarfs every other emerging market. There’s no reason to keep it in a traditional emerging market index. It doesn’t have to be added to developed market indexes, but it’s big enough to stand on its own. For those investors who like to get granular with their U.S. investments, targeting certain factors or strategies, it seems like doing the same for China would be a smart step to take.