What lies ahead for China ETFs?

 

China’s manufacturing purchasing managers index (PMI) edged down in February, as the Lunar New Year holiday contributed to slowing of business activities.

China’s economy grew 6.9% in 2017 compared with 6.7% in the previous year, the first annual acceleration since 2010. It was also way above the government’s full-year target of 6.5%. Government infrastructure spending and strong export growth helped the economy post better-than-expected results. However, the data still shows a slowdown in early 2018, as the government’s crackdown on pollution and sky-high levels of debt weigh on the economy.

“Although a recovery looks possible in the short-run as the anti-pollution campaign winds down, the risk is still that the economy fares worse this year than is generally expected,” per a Reuters article, citing a statement by Julian Evans-Pritchard, senior China Economist at Capital Economics.

More Into the Headlines

Manufacturing PMI decreased to 50.3 in February compared with 51.3 in the prior month and below a Reuters forecast of 51.2, per China’s National Bureau of Statistics. A reading above 50 indicates expansion.

Moving on to factors that edged down PMI, the decline was primarily because a number of factories were shut for some time in February, as the Lunar New Year holidays fell in mid-February this year. The sub-index measuring new orders fell to 51.0 from 52.6 in the prior month, while the production sub-index fell to 50.7 from 53.5.

Risks Involved

PMI data shows the country’s current scenario and business conditions. It helps judge the impact of policymakers’ focus on reducing pollution and financial risks on the economy. Adding to the agony, events at Wall Street are also not helping Chinese equities much. Interest rate hike expectations might prompt investors to shun Chinese equities and increase the appeal of domestic investing.

Jerome Powell’s testimony was seen indicative of the possibility of Fed raising rates more than three times in 2018. “In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE [personal consumption expenditures] price inflation to 2% on a sustained basis,” per a Financial Times article, citing a statement by Powell.

Coming to authenticity of economic data, multiple analysts argue that China’s official data is anybody’s guess and cannot be completely trusted. Recently, provinces of Liaoning and Jilin, the city of Tianjin and parts of Inner Mongolia admitted that their 2016 economic numbers were overstated.

From a political risk perspective, the Chinese Communist Party amended its constitution to remove presidential term limits and allow a third term for President Xi Jinping. Being the number two in the world currently, Xi’s policies are expected to greatly shape up global peace and policies, as he aims to take China closer to being the number one country, at the expense of sour relations with his peers in Washington.

What’s worrying is that the first annual acceleration in GDP growth is making policymakers think that they are on the right track, while turning a blind eye toward reforms actually needed to enhance foreign investment. From a long-term horizon perspective, this introduces massive uncertainty for investors eyeing investing in the emerging market nation.

Let us now discuss a few ETFs focused on providing exposure to the Chinese economy.

iShares China Large-Cap ETF FXI

This fund seeks to provide exposure to Chinese equities, serving as a pure play on the economy.

It has AUM of $4.6 billion and is a relatively expensive bet as it charges a fee of 74 basis points a year. From a sector look, Financials, Energy and Information Technology are the top three allocations of the fund, with 55.2%, 11.4% and 9.2% exposure, respectively (as of Feb 26, 2018). From an individual holding perspective, China Construction Bank Corp, Tencent Holdings Ltd and Industrial and Commercial Bank of China are the top three allocations of the fund, with 10.2%, 9.2% and 7.9% exposure, respectively (as of Feb 26, 2018). The fund has returned 28.9% in a year. FXI has a Zacks ETF Rank #3 (Hold), with a Medium risk outlook.

iShares MSCI China ETF MCHI

This ETF is another such option to play the BRIC nation.

It has AUM of $3.5 billion and charges a fee of 62 basis points a year. From a sector look, Information Technology, Financials and Consumer Discretionary are the top three allocations of the fund, with 41.8%, 23.2% and 9.3% exposure, respectively (as of Feb 26, 2018). From an individual holding perspective, Tencent Holdings Ltd, Alibaba Group Holding ADR and China Construction Bank Corp are the top three allocations of the fund, with 18.8%, 12.7% and 5.2% exposure, respectively (as of Feb 26, 2018). The fund has returned 45.8% in a year. MCHI has a Zacks ETF Rank #3, with a Medium risk outlook.

SPDR S&P China ETF GXC

This fund has AUM of $1.2 billion and charges a fee of 59 basis points a year. From a sector look, Information Technology, Financials and Consumer Discretionary are the top three allocations of the fund, with 36.9%, 23.1% and 10.5% exposure, respectively (as of Feb 26, 2018). From an individual holding perspective, Tencent Holdings Ltd, Alibaba Group Holding ADR and China Construction Bank Corporation are the top three allocations of the fund, with 15.7%, 11.0%, and 5.8% exposure, respectively (as of Feb 26, 2018). The fund has returned 43.6% in a year. GXC has a Zacks ETF Rank #3, with a Medium risk outlook.

ISHARS-CHINA LC (FXI): ETF Research Reports

SPDR-SP CHINA (GXC): ETF Research Reports

ISHARS-MS CH IF (MCHI): ETF Research Reports

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Symbols: FXI GXC MCHI
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