China ETF Outflows Persist Despite Rally

These large China ETFs are rallying sharply, but losing assets as they rise. 

The largest Chinese equity ETFs are delivering a solid performance this year. But no one seems to be buying into it.

On the contrary, investor interest in the ongoing rally fueling these ETFs higher is muted at best, with some of these funds facing net redemptions—not creations—so far in 2017. So much for performance chasing.

Consider the three largest China equity ETFs by assets:

• iShares China Large-Cap ETF (FXI)
• iShares MSCI China ETF (MCHI)
• SPDR S&P China ETF (GXC)

The worst performing of the bunch is up a healthy 25%, while the best performing has rallied 41% year-to-date. Compare these returns to the SPDR S&P 500 ETF Trust (SPY), which is up 10% this year. 

FXI, the largest China ETF investing in the country’s large-cap segment, with $3.3 billion in total assets, has seen net outflows of some $150 million year-to-date even as it rallied 25%.

MCHI, the second largest, with $2.6 billion in AUM, has now bled $286 million this year. GXC, at No. 3, with almost $1 billion in total assets, has seen $50 million in net outflows.

Why that has occurred is puzzling many.

It could be all about aversion to single-country risk for a country that’s known for political and economic risk. It could also be simply about profit-taking after a solid run. And it could be about smaller ETFs taking market share from the big three.

Reason No. 1

“Despite the Chinese market helping drive more diversified emerging market equity ETFs, the [China ETF] products have not been popular,” said Todd Rosenbluth, director of ETF and mutual fund research at CFRA, an independent research firm.

“Rather, investors have focused more on the low-cost iShares MSCI Core Emerging Markets (IEMG) and the Vanguard FTSE Emerging Markets ETF (VWO) this year,” he said. “Exposure to China is larger there than to other countries, but investors also get stakes in India, Taiwan and others.”

There’s no doubt that with IEMG and VWO, investors are saving on out-of-pocket costs. FXI, MCHI and GXC all have expense ratios ranging between 0.59% and 0.74%, while IEMG and VWO both cost 0.14%—less than a quarter of the cost.

They are also diluting single-country risk in a broader emerging market fund by owning China through portfolios where China represents 25-28% of the overall mixes. And as a whole, the performance of these broader emerging market ETFs has also been good this year:

Reason No. 2

But the ongoing outflows from China ETFs could also suggest that investors are taking profits, according to Dave Garff of Accuvest, which specializes in single-country allocations.

“I think the emerging market trade has become a little bit of a consensus call, but for the most part, it’s become a trade,” Garff said. “Given the outperformance of EM this year, a lot of managers are taking profits and moving back to more neutral positions.”

China, in particular, he says, has only been outperformed in the past 12 months—among the investable countries in the All Country World Index—by Poland and Austria, and ETFs tapping into those countries have attracted assets.

“Interestingly, neither Poland nor Austria carry the same perceived political risk as China,” Garff noted. “But maybe that’s just an excuse for people to take profits. If you’re up 40% on a position in 12 months and the market is up 17%, you might just want to sell.”

Reason No. 3

There’s yet another possible explanation. The Nos. 4 and 5 China ETFs in terms of assets have actually been gainers of fresh net assets this year.

The KraneShares CSI China Internet ETF (KWEB)—the best-performing China ETF in 2017 so far—has attracted $375 million in net creations year-to-date. The fund, which focuses exclusively on China’s tech sector, has $765 million in total assets. It has grown dramatically this year, while returning 63%, so-performance chasing hasn’t completely abandoned China ETFs.

At No. 5, the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR), the first ETF to offer access to China’s A-shares market, and a fund that offers total market exposure to China’s mainland stocks, has raked in about $70 million in inflows. ASHR has $524 million in total assets.

Neither of these two funds has a particularly cheap expense ratio—0.72% and 0.65%, respectively. So buying into these funds wasn’t necessarily about cost. It could be all about strategy.

“I don’t know for a fact that these were swaps, but if you look at the numbers, they’re almost exactly the same amounts,” Garff said of the outflows from the top three and inflows into smaller funds. “So maybe managers are just changing horses within China.” 

Chart courtesy of StockCharts.com

Contact Cinthia Murphy at [email protected]