A disappointing economic performance as it exited zero-Covid policies, a property crash in 2023 and ongoing geopolitical tensions with the US over Taiwan have caused some investors to lose faith in investing in China in the last couple of years.

In terms of ETFs, this has meant investors turning their attention to emerging market funds which specifically exclude the world’s second-largest economy from their asset allocation.

This would seem to be backed up by data from Morningstar Direct which shows ETFs with ‘ex-China’ in their title saw a notable increase in their total net assets between November 2022 and November 2023.

GOING ‘EX-CHINA’ DELIVERS IMPROVED RETURNS

An ‘ex-China’ emerging markets ETF does exactly what it says on the tin, providing exposure to emerging markets without including China.

Over the course of the last three years, this approach has delivered a superior performance compared to broad-based emerging-market ETFs which include a badly-listing Chinese stock market.

Over the past year, the iShares MSCI EM ex-China (EXCS) has returned 11.9% and cumulative returns over the last three years have been 9.5%.

Meanwhile, the Amundi MSCI Emerging Ex China UCITS ETF Acc (EMXC) has returned 11.4% over the past year and 8.6% over three years.

In contrast, the largest broad-based emerging-market ETF, iShares Core MSCI Emerging Markets IMI (EMIM), has chalked up an 8.9% return over one year and negative returns of -4.4% over three years.

HOW DO MSCI EMERGING MARKETS AND MSCI EX-CHINA EMERGING MARKETS INDICES COMPARE?

Apart from the obvious – i.e., the lack of Chinese exposure in one of these indices and the recent divergence in performance – there are some other notable distinctions between the two. Once Chinese names are stripped out, Taiwanese chipmaker Taiwan Semiconductor Manufacturing Company (2330:TPE) has a more dominant position in the index with a weighting in double digits in percentage terms. As the pie charts show, the ex-China index has a larger weighting to information technology and a significantly lower weighting towards consumer discretionary stocks relative to its counterpart.

POTENTIAL CHINA RECOVERY

Chinese markets have been showing some signs of recovery in recent months, so in the short term at least buying an ex-China emerging markets ETF would have diluted your gains. Over the past three months, the China-focused HSBC MSCI China UCITS ETF (HMCH) has returned 20.53%.

In the first quarter of 2024, China’s economy was stronger than expected due to growth in high-tech manufacturing, with GDP (gross domestic product) expanding by 5.3% on the same period a year ago according to the National Bureau of Statistics, beating the estimate of 4.6% growth from a Reuters poll of economists.

Industrial output jumped 6.1% during the quarter as production of 3D-printing equipment, charging stations for EVs (electric vehicles) and electronic components all surged about 40% compared to a year earlier.

The Chinese government also recently announced a $40 billion rescue package to help state-backed firms buy unsold properties from builders, sending the Chinese property sector index up 10% in a  single day.

NOT IN CRISIS TERRITORY

Dina Ting, head of global index portfolio management at Franklin Templeton, says: ‘China’s stock market has certainly been battered, rattling both consumer and investor confidence. But we wouldn’t be so quick to categorise this disappointing stage as a crisis.

‘Investors should still tread cautiously, of course, given Chinese consumers remain nervous about a still-shaky property market and high youth unemployment.

‘But they should not completely write off the growth potential of China’s domestic market—one arguably too big to ignore.’

Ting adds: ‘Private investment in AI (artificial intelligence) and a tightening of the rules related to short selling are all attempts to restore investor confidence [in China].

‘While investors do not expect a swift rebound in China’s market, some are seeing alluringly cheap valuations as an attractive entry point to the world’s second-largest economy.’

LONGER-TERM REASONS TO AVOID CHINA

Investors may still want the flexibility afforded to them by ex-China products for several reasons.

One is simply how dominant China is in emerging markets indices. In the MSCI Emerging Markets index, for example, China has a 27% weighting – nearly 10% more than India, the next largest market.

An ex-China ETF arguably represents a more diversified way of gaining exposure to the higher levels of growth from emerging markets – underpinned by more youthful populations and emerging middle classes.

Partly as a result of the one-child policy instituted in China between 1980 and 2016, China actually has population with an age profile more akin to the West than other developing countries like India.

This brings with it challenges, notably a shrinking working age population being required to support a growing elderly subset and increasing demand in areas like health care.

Unlike other large emerging markets such as India and Brazil, China is not a democracy and has a difficult relationship with Western nations which brings with it layers of geopolitical risk, particularly over the thorny issue of Taiwan’s nationhood.

Corporate governance standards, the transparency of company reporting and levels of government interference can be further hazards when investing in China.

WATCH THE COSTS

It is worth noting you may have to pay slightly more if you want an ETF which carves out China.

The iShares MSCI EM ex-China fund has the same ongoing charges figure as its mainstream emerging market product at 0.18%.

However, the Amundi MSCI Emerging Ex-China fund, while being slightly cheaper at 0.15%, is more expensive than the group’s plain-vanilla emerging-market fund, Amundi Prime Emerging Markets (PRAM), which has an ongoing charge of 0.10%. 

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