Will Owning Chinese Stocks Hurt Or Help Investors In The Future?

Emerging-market ex-China ETFs, which outperformed broader emerging market funds during periods of US-China trade tensions, are now underperforming, leading to investor outflows; for example, the iShares MSCI Emerging Markets ex China ETF (EMXC) has seen nearly $3 billion in outflows YTD. While short-term performance lags due to potential US-China trade deals benefiting China, some analysts suggest a strong long-term outlook for ex-China funds due to supply chain diversification and geopolitical considerations, with investors potentially using them to fine-tune their China exposure alongside broader EM funds.

Analysis

Investor sentiment towards emerging market (EM) ex-China ETFs has shifted in 2024, with these products experiencing net outflows and relative underperformance compared to broader EM ETFs that include Chinese equities. For instance, the iShares MSCI Emerging Markets ex China ETF (EMXC), despite a respectable year-to-date return of approximately 12%, has seen $2.9 billion in net outflows this year, with $2 billion departing since May 1. In contrast, the iShares Core MSCI Emerging Markets ETF (IEMG), which has a 28% allocation to China, has attracted $2.9 billion in net inflows year-to-date and delivered a 14% return. This trend, highlighted by Todd Rosenbluth of TMX VettaFi, marks a departure from 2023 and early 2024 when ex-China strategies were favored due to China's underperformance amidst U.S.-China trade tensions. The current dynamic is partly attributed by Aniket Ullal of CFRA Research to expectations of a U.S.-China trade deal, which could temporarily favor Chinese assets. However, the long-term rationale for ex-China strategies remains compelling, supported by factors such as U.S. political sentiment, corporate efforts to diversify supply chains away from China towards countries like Mexico, India, or Vietnam, and growing institutional demand, evidenced by Vanguard's plan to launch a low-cost EM ex-China ETF following requests from entities like the State of Missouri's pension fund, which divested from Chinese stocks in late 2023. Ex-China ETFs also offer a strategic tool for investors to fine-tune their specific allocation to China when used in conjunction with broader EM funds like the Vanguard FTSE Emerging Markets ETF (VWO), which holds 32% in Chinese stocks and is up 12% this year.

Key Decisions for Investors

• Investors should acknowledge the current underperformance and outflows from ex-China ETFs, such as EMXC, relative to China-inclusive EM funds like IEMG, potentially reflecting short-term market dynamics and a sentiment shift.
• Consider the strategic long-term case for maintaining or initiating ex-China EM exposure, driven by geopolitical diversification, supply chain realignments, and increasing product availability catering to specific mandates.
• Evaluate the utility of ex-China ETFs as a tactical tool to precisely calibrate overall China exposure within an emerging markets portfolio, rather than relying solely on broad EM ETFs where China often constitutes a significant, less flexible, weight.