One of the best-performing markets of 2017 was also one of the most overlooked and unloved this year: China.
Unlike previous years, China did not dominate headlines and capture massive investor attention despite a lot of focus on emerging market equities in 2017. Instead, the largest China ETFs were net asset losers this year.
The biggest, the $3.6 billion iShares China Large-Cap ETF (FXI), saw net outflows of $150 million year-to-date; the second biggest, the iShares MSCI China ETF (MCHI), bled a net of $446 million; the third biggest, the SPDR S&P China ETF (GXC), faced almost $50 million in net redemptions.
These aren’t huge redemptions, but they are redemptions nonetheless in a year when these funds performed strongly relative to broader emerging market ETFs—as represented below by the iShares Core MSCI Emerging Markets ETF (IEMG)—and relative to the S&P 500.
What’s The Disconnect?
Perhaps one of the biggest drivers of this disconnect between the performance of the market and ETF investor demand for China equities is a misunderstanding about China’s growth story. It’s about domestic consumption and not headline gross domestic product (GDP).
“China’s strong economic performance has been a key driver of equity returns as policies to increase domestic consumption and reform of state-owned enterprises have led to strong equity performance,” said Brendan Ahern, chief investment officer at KraneShares.
“There has been an overemphasis on China as an exporter while missing the rise of domestic consumption,” he noted. “Ultimately, China’s economy and corporate earnings had a great year in 2017, and both surprised to the upside.”
Traditionally, U.S. investors have placed most of their attention on China’s GDP growth, looking for signs of an economic slowdown that could ultimately impact equity prices. And Chinese growth has slowed in recent years.
Short Interest In FXI Growing
That has put China in the “unloved” and “underowned” categories of many ETF investor portfolios, according to Tyler Mordy, president and CIO at Forstrong Global Asset Management, so much so that short interest for FXI is massive, he says.
“The most important facts about China today are not the problems of slowing growth and high leverage,” Mordy explained. “Rather, they are the shift away from exports and capital spending to consumer-led growth, improving margins and financial liberalization.”
“The main piece of macro misinformation about China is that a crash is inevitable,” he added.
To him, what’s missing is a grasp on the fact that China’s economy is transitioning from an industrialization phase marked by fast growth to a more mature, resource efficiency phase where growth is slower.
“Over the next several years, China will see slower but better growth due to reduced capital waste and improved profitability,” said Mordy. “Now is the time to be investing in an unloved sector.”