The China Problem…And ETF Solution
China is now the world’s second-largest economy, and is expected to surpass the U.S. at some point in the not-so-distant future. The country accounts for a huge portion of global GDP growth, and has contributed to the expansion of countless economies around the globe thanks to its insatiable appetite for raw materials.
Yet many U.S. investors are drastically underexposed to the Chinese stock market; the allocations afforded to this country in most investor portfolios simply do not correspond to the current economic footprint of China or the country’s long-term growth potential.
Consider a simplified equity portfolio comprised of equal allocations to U.S. stocks (through VTI), developed markets outside North America (through EFA), and emerging markets (through VWO):
|VTI||Total Stock Market ETF||33.3%|
|EFA||MSCI EAFE Index Fund||33.3%|
|VWO||Emerging Markets ETF||33.3%|
This equity portfolio would make an allocation of about 5% to China’s stocks market. Yet on a PPP basis, China’s economy accounts for about 14% of the total global economy. In simple population terms, China accounts for nearly 20% of the world total.
It is a similar story in ETFs that purport to offer one stop exposure to the global economy. China makes up less than 3% of the portfolio of the iShares MSCI All Country World Index Fund (ACWI) and only about 4% of the All Country World ex-U.S. Index Fund (ACWX).
Moreover, achieving exposure to China through broad-based products focused on emerging markets or the global economy generally results in overweight exposure to large cap stocks. That means that most U.S.-based investors achieve the entirety of their exposure to China, a major source of growth potential, through a small handful of mega cap oil companies and banks. This approach may include firms that are owned in large part by the Chinese government, and will more than likely include access that is limited in terms of sector balance and long-term capital appreciation.
…And China ETF Solution
Fortunately, there are a number of easily accessible tools available for investors looking to address the limitations in their China exposure. For investors looking to establish a more balanced China profile that includes all corners of the economy, there are nearly two dozen exchange-traded products that allow for both broad-based and targeted access to the Chinese economy.
Of course, not all China ETFs are created equal. Some are more appropriate for investors maintaining a long-term, buy-and-hold approach, while others may be ideal for those with a more specific short-term outlook on various segments of the Chinese market. The following sections of this report highlight some of the critical questions to ask when evaluating the various options out there, as well as valuable comparative metrics and analyst insights.