Amid the vast ETF landscape, investors are bound to run into seemingly-identical offerings from different issuers. In many of these instances, the differences between the products are often trivial; sometimes it’s just a few basis points in the expense ratio or slight differences when considering the underlying holdings. On the other hand, there are instances when two ETFs operating under the same umbrella are in fact quite different from one another [see also When the Fine Print Matters for ETF Investors].
Below we’ll take a closer look under the hood of two popular China ETFs that many might suspect to be one in the same, but in fact, are very different from each other.
In the China Equities category, FXI stands head and shoulders above the rest of the offerings in terms of assets under management; this iShares ETF boasts over $5.3 billion in AUM, while the next biggest China-focused ETF, the iShares MSCI China Index Fund (MCHI), commands just over $1 billion in AUM. Moving down the list, Deutsche’s Harvest CSI 300 China-A shares Fund (ASHR), boasts just over $300 million in assets under management and is the fifth biggest vehicle in this category.
Consider the graph below which showcases the cumulative returns of FXI and ASHR, spanning from the latter funds’ launch date, 11/6/2013, through 8/11/2014:
What’s the Major Difference?
The straightforward answer as to why these two seemingly-identical ETFs don’t boast identical returns is because they focus on different segments of China’s equity market. Just because both ETFs fall under the “China Equities” category does not mean they go about providing exposure to this asset class in the same way [see FXI vs. ASHR: Head-To-Head ETF Comparison].
FXI’s portfolio is comprised of roughly 30 large-cap securities, namely well-known ADRs, with a very heavy tilt (50% of total portfolio) towards the financials sector; adding to that, FXI’s top ten holdings account for approximately 60% of the entire portfolio.
ASHR on the other hand is comprised of 300 securities, specifically A-Share stocks listed on the Shenzen or Shanghai stock exchanges; furthermore, its top ten holdings make up just over 20% of the entire portfolio. The A-Shares market spans a different universe of securities than what is included in FXI as it is comprised of mainland Chinese equities that are notoriously difficult for foreign investors to access. To learn more about why ASHR is different from almost every other China ETF be sure to read Inside the China A-Shares Fund: A Better Way to Invest Overseas.
In summary, the major difference between FXI and ASHR is the way they go about offering exposure to China; FXI does this through a shallow, top-heavy portfolio of large-cap ADRs, whereas ASHR takes a more diversified, broad-based approach and targets lesser-known securities from the country.
What’s Driving the China Rally?
The difference in portfolios however isn’t reason enough to explain the recent performance gap between FXI and ASHR. In other words, we need to dig a little deeper and examine why Chinese equities have begun to rebound in the first place. One of the most obvious reasons is improving sentiment surrounding the nation’s economic growth. This shift in sentiment, from fearful to optimistic, has been fueled by better-than-expected manufacturing data. China’s manufacturing PMI, one of the most widely followed leading indicators for the country, has been steadily rising and beating expectations since hitting a low point in February of this year [see 3 Emerging Market ETFs Not Dependent on China].
The second, and less talked about, reason for why investors have turned more bullish on China has to do with recently announced reforms in the nation’s financials sector. On March 11th, right around the time when FXI and ASHR bottomed, China announced the launch of a pilot program that would establish five banks owned entirely by private, and not government-backed, institutions. This was seen as a “game changer” in the eyes of many seeing as how it marked a major step forward in easing restrictions on the nations’ government-controlled banking industry.
When we consider this news of improving sentiment surrounding the nation’s financials sector, it becomes more apparent as perhaps why FXI has been able to outpace ASHR in recent months. Remember FXI’s shallow, top-heavy portfolio? Well that’s a major reason why this ETF has been able to outperform its more diversified competitor ASHR. Because six of the top ten holdings in FXI are financials, and remember that the top ten holdings make up 60% of the entire portfolio, it’s no wonder that this ETF has been able to outperform ASHR in recent months.
Put another way, because much of the euphoria in China’s equity market has stemmed from news of de-regulation of the financials sector, FXI’s shallow, top-heavy portfolio has been able to benefit more from this than ASHR’s deeper, more diversified basket of holdings. While FXI’s heavy skew towards the financials sector may be seen as a detriment to long-term investors, its portfolio composition has served it well in recent months given the upbeat developments surrounding China’s banking industry.
The Bottom Line
Always take a good look under the hood of a product before pulling the trigger; there are countless examples of deceiving ETF names as well as products that don’t exactly work how you might expect them to. In the case of the China ETFs profiled above, investors looking for liquid, concentrated exposure are better off with FXI, while those in it for the long-haul are likely to find ASHR’s balanced portfolio a bit more compelling.
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Disclosure: No positions at time of writing.