China ETFs Overlooked & Unloved In 2017

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.”

Technology Shines

If investors are largely missing the big picture about China’s economy, asset flows also suggest that they are bullish on China’s technology. Data points such as Alibaba’s record breaking sales and Chinese consumer increasing online shopping and tech reliance are helping push this segment forward.

The year’s most popular China ETF was the KraneShares CSI China Internet ETF (KWEB), which attracted more than $685 million in net creations this year. That amounts to a 64% growth of assets under management this year for KWEB.

The Guggenheim China Technology ETF (CQQQ) came in second, with net inflows of $324 million, an AUM jump of 76%.

These flows came as these funds delivered more than twice the gains of broader, total market China ETFs such as FXI—almost 70% in gains this year. 

Notable Standout ETF

Third on the list, with a massive 87% jump in AUM, is also the best-performing China ETF this year (excluding leverage and inverse), the WisdomTree China ex-State-Owned Enterprises Fund (CXSE).

CXSE is a total market fund that excludes state-owned companies, focusing instead on private companies believed to be run more efficiently. CXSE is up almost nearly 80% this year.

CXSE remains a relative small fund, with $151 million in total assets amassed over five years since inception. But throughout its history, the fund has once changed index and focus, and this past August, it added China A-shares—stocks listed in mainland China—to the portfolio for the first time. 

A-Shares Effect

Finally, a note about China’s A-shares market. According to Ahern, MSCI’s June decision to begin including China A-Shares in its benchmark emerging markets index in 2018 sparked a rally in China’s onshore market.

The largest China A-Shares ETF, the Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR), rallied some 31% this year, just slightly trailing FXI’s results. Investors poured $110 million into ASHR this year, making it the sixth-most popular China ETF year-to-date in 2017. 

Charts courtesy of StockCharts.com

“As China makes progress in face of the many naysayers‎, equities have much room to be revalued upward,” Mordy said. “The recent decision by MSCI to add 222 China A-share stocks starting in May 2018 is icing on the cake. Stay long FXI and ASHR.”

Top China ETF Gainers YTD 2017

Top China ETF Losers YTD 2017

Contact Cinthia Murphy at [email protected]