China In Perspective

China In Perspective

The government crackdown on certain types of companies in China has made many investors nervous.

Reviewed by: Gerrard Cowan
Edited by: Gerrard Cowan

[This article appears in our January 2022 issue of ETF Report.]


2021 was a tough year for China-focused equity ETFs amid regulatory crackdowns, strained U.S. relations and concerns regarding human rights and foreign policy. Still, the country remains a massive market with a range of growth prospects. So how can investors navigate this complex environment?

As of Nov. 30, 2021, most of the 10 biggest U.S.-listed China equity funds were down anywhere from almost 4% to more than 40%, with even the nearly $5 billion iShares China Large-Cap ETF (FXI) down 13%. However, there were some relative bright spots, such as the VanEck ChinaAMC SME-ChiNext ETF (CNXT), up more than 11% year-to-date.

Meanwhile, the iShares MSCI China A ETF (CNYA) was up more than 2%, and the KraneShares Bosera MSCI China A Share ETF (KBA) was up almost 2%. Funds focused on China A-shares are less dependent on the consumer discretionary sector, which has been under pressure, says Todd Rosenbluth, head of ETF and mutual fund research at CFRA.

Many investment analysts are growing warier of the giant market. Rosenbluth sees “the risk being elevated given the increased volatility.” Many investors are already getting hefty exposure to China via broader emerging market or regionally focused ETFs, he says, which may be enough for now.

“We wouldn’t be overweighting,” he noted. “We’d certainly look to find other areas in which to invest in emerging markets.” Rosenbluth highlights India and Taiwan, both of which are “better positioned, with fewer regulatory risks and thus more upside potential, in our opinion.”

Complicated Scenario
But it’s a complex picture, according to Ben Johnson, director of global ETF research for Morningstar. The largest China-focused equity fund by AUM is the KraneShares CSI China Internet ETF (KWEB), with assets of about $8.9 billion and negative returns year-to-date of just over 42%. However, KWEB attracted large inflows in 2021. While “at face value, that seems somewhat counterintuitive,” Johnson says, it suggests U.S. investors still see potential in the Chinese internet domain.

KraneShares specializes in the Chinese market. Its Chief Investment Officer, Brendan Ahern, thinks it’s a mistake to view China “as this singular entity.” For example, regulatory actions are being pursued by different regulators moving at different speeds, he says. That can feel somewhat ad hoc to outsiders, he notes, sometimes pushing them to the sidelines because they don’t understand what’s happening. However, at least when it comes to the internet sector, Ahern feels “we might even be done with this regulatory cycle … there are green shoots that indicate the worst is likely behind us.”

For example, Ahern pointed to a recent speech by Vice Premier Liu He in which the senior official highlighted the importance of the private economy, which he said accounts for 50% of tax revenue, 60% of GDP and 80% of urban employment. “We believe this was really messaging,” Ahern said.

State Street Global Advisors (SSGA) operates the SPDR S&P China ETF (GXC), a $1.6 billion fund that’s down just over 17% year-to-date. Matt Bartolini, SSGA’s head of SPDR Americas Research, says Chinese stocks have faced a range of head winds. Additionally, the country’s growth expectations, while still above those of the U.S., are lower than in the previous years, he notes.

Still, exposure to China is hard to avoid, Bartolini suggests, and “definitely warrants consideration, even as part of a broader EM strategy.” The country’s GDP is about six times bigger than that of India, the next-largest EM economy. “Just because of the sheer size alone, I think it continues to warrant an allocation, in some cases a stand-alone allocation,” he said.

Multifaceted Market
Despite all the concerns, “investors are helped by the fact that it’s such a large market,” noted William Sokol, product manager for ETFs at VanEck, which operates funds like CNXT.

“You can be selective,” he said. “You can slice and dice the opportunity set.” For example, investors could focus on sectors according to the perceived regulatory risk, or look more to balance sheet fundamentals.

The Emerging Markets Internet & Ecommerce ETF (EMQQ)—a $1.1 billion fund that’s down about 27% year-to-date—offers exposure to the growing internet and ecommerce sectors in emerging markets. The fund is naturally dominated by Chinese companies, which comprise about 60% of holdings by weighting.

In September, the team behind EMQQ launched the Next Frontier Internet & Ecommerce ETF (FMQQ), which focuses on similar themes but excludes China. However, EMQQ and FMQQ Founder Kevin Carter insists the new launch doesn’t stem from concerns about China, but simply provides access to “a different sort of opportunity set,” focused on markets at a much earlier stage of development.

Indeed, Carter thinks many of the fears about China are unfounded, noting other countries are also increasingly focused on regulating their internet sectors, for example. 

“They understand capitalism, they’ve benefited from it more than anybody,” Carter explained. “They’re unlikely to move away from capitalism in spite of what the headlines might have you think.”

Excluding China
Other funds look beyond the Chinese market and see potential financial benefits to that approach. Perth Tolle is founder of Life & Liberty Indexes, which built the index behind the Freedom 100 Emerging Market ETF (FRDM), a fund that invests in companies with high scores for personal, political and economic freedom. That means China is excluded.

The fund was launched in May 2019, so had its first full year during COVID-19. “Our thesis that freer markets recover faster played out,” explained Tolle. “The assets came in faster after that, but they really accelerated in 2021, after the Chinese government’s actions against their tech, education, and real estate sectors.” The fund’s assets have more than doubled in the second half of 2021, she says, sitting at about $105 million today. It’s seen returns of just under 3% this year.

“Investors can better capture growth in the stock markets of freer countries, due to rule of law and private property rights, including shareholder rights,” she argued. “The freer EMs are where we’ll find and capture the growth stories of the next decade.”

Arne Noack is head of systematic investment solutions, Americas at DWS Group, which operates the Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR), a $2.3 billion fund that’s down almost 4% year-to-date. For those interested in longer-term investments, he posits that, “the China equity market is something to always consider.”

While he recognizes the concerns regarding geopolitical and economic risks, Noack stresses the need for investors to attempt a careful balance: “Consider it with some caution, but don’t dismiss it outright. In dismissing it outright, you’re likely to forgo significant opportunities in the long run.”

Finding A Balance
In the grand scheme of things, China- focused ETFs are a fraction of the overall universe of U.S.-listed ETFs, says Morningstar’s Johnson. ETFs belonging to Morningstar’s China region category held a combined $38 billion in assets as of the end of October, compared with just over $7 trillion in U.S.-domiciled exchange-traded products.

Most investors likely gain their China exposure through a more diversified portfolio, such as an emerging market stock index ETF. The majority also continue to favor their home markets, whether they’re based in the U.S. or any other country, Johnson says, adding that, in most cases, they’ll likely be best served through an allocation to emerging markets at large: “For many investors, what’s going on in Chinese stocks on any given day or week or month or year probably isn’t keeping them up at night.”

Gerrard Cowan is a freelance journalist who writes on finance and technology. He previously worked at The Wall Street Journal, where he edited the Business & Finance section of the European edition, and at Jane's Defence Weekly. Gerrard is the author of “The Machinery” fantasy novels, published by HarperCollins.