How to get a slice of China with ETFs
China is reliably predicted to overtake the US as the world’s largest economy within a decade. While many investors have a high allocation to the US market, China is often an after-thought in a portfolio. But if you believe in the long-term growth of China, ETFs are a great way to bump up your exposure.
Why invest in China?
China is the world’s second largest economy and growing fast. It grew by 8.1% in 2021, outpacing all major developed markets. However, the International Monetary Fund (IMF) downgraded its growth forecast for 2022 to 3.2% in November, in a move largely attributed to the disruption caused by the country's numerous regional lockdowns and the ongoing financial struggles of its largest property developers.
However, China's GDP is expected to pick up to 4.4% in 2023, and though this is still considerably below Beijing's stated 5.5% target, it's worth looking at these figures with a global perspective. According to Reuters, using last year's nominal country GDP figures as a base and applying the IMF's 2022 and 2023 growth estimates, China will actually account for as much as 30% of aggregate global growth next year (which the IMF expects to reach 2.7%).
In fact, following this estimate, China’s contribution to global growth will be more than three times that of the United States. So despite a blip in progress this year, in a post-pandemic world struggling to generate economic growth, China remains a hotspot nonetheless.
This has been reflected in the growth of the region’s stock markets. They have grown and diversified, with real strength in areas such as the internet and green energy. Returns for investors have been bumpy, but the country still offers a wealth of opportunities for investors who can hold their nerve.
Historically, investors have largely accessed China through broader emerging market ETFs. These typically have around one third of their exposure in China, but also include a lot of other emerging markets too. However, the choice of China-specific ETFs on the market is growing.
Why use ETFs to invest in China?
ETFs are a cheap and liquid option to gain access to China’s long-term growth story, allowing investors to gain diversified exposure to Chinese markets with a small initial investment, and providers are offering an increasingly broad range of options as this demand grows.
One thing to note is that ETF providers will offer exposure to the two main markets – the ‘H’ shares, which are traded in Hong Kong, and the domestic ‘A’ shares, which are traded in Shanghai. There is also the option to access targeted segments of the Chinese market, such as consumer spending or smaller companies.
An increasingly popular area of investment is China's clean energy scene, which has grown rapidly in recent years as it attempts to have renewable energy account for 35% of its electricity consumption by 2030.
What types of China ETFs are there?
Investors have a vast choice when it comes to China ETFs. At the ‘vanilla’ end, there are the large, diversified ETFs based on well-recognised China indices, such as the iShares MSCI China ETF. These will give investors exposure to a range of Chinese companies, weighted towards its largest names – Tencent, Alibaba, JD.com and China Construction Bank to name a few.
There are also a range of ETFs providing dedicated exposure to the ‘A’ shares market. This is a particularly exciting area, says Edward Malcolm, Head of UK ETF Distribution at JP Morgan Asset Management.
“As it stands, China’s weight in most indices doesn’t reflect the real size of China’s market capitalisation. The domestic ‘A’ shares market currently only represents 5% of the MSCI emerging market index. If its weight was fully reflected, it would be over 20%", he adds. As the MSCI index adjusts over time, it should create positive flows into the market.
The ‘A’ share market tends to be more volatile, because there are a lot of retail investors involved in it. However, it does bring investors more exposure to opportunities in domestic China.
There are also active ETFs focused on China, and at the more specialist end, there are also China ETFs looking at smaller companies, or focusing on specific sectors, such as the internet - not to mention the increasing number of ETFs with an ESG overlay.
What are the risks of investing in China?
While there is a lot of excitement around the long-term growth of China, it's still an emerging nation with an authoritarian government, which has put it at odds with Western powers - particularly the US. This has an impact on Chinese companies, who may be prevented from accessing Western markets and intellectual property. More recently, a number of Chinese companies have been de-listed from US stock exchanges, which has hurt share prices.
Equally, the government is not afraid of interfering in the corporate sector if it feels it's doing social harm or interfering with its agenda. The government has clamped down on social media companies and online education providers in the past, with a meaningful impact on their business. This has spooked investors, and while we haven't seen a repeat of this for other industries, it showed the Chinese corporate sector who's in charge.
So Chinese markets are volatile. As such, any investment in the country needs to be looked at as a long-term commitment – five years or more - and as part of a wider, diversified portfolio.
How can you use China ETFs in a portfolio?
Chances are, you may already have some exposure to China as part of a diversified portfolio. But a China-specific ETF can be a great tool to bump up that holding for those who believe in its long-term growth prospects.
As always, before making a commitment, you should check what you already hold to make sure you're not duplicating any investments unnecessarily, and also check the holdings of any ETF you're considering purchasing so you know exactly where your money is going.
China ETFs can be used to gain additional exposure to Chinese companies, or to get new exposure to areas that aren't well-represented elsewhere, such as the ‘A’ shares market.
Top performing China ETFs
The China ETFs with the highest returns in 2022 were:
Amundi ETF MSCI China UCITS ETF USD [CC1G] | 2.11%
KraneShares CSI China Internet UCITS ETF EUR [KWBE] | -5.52%
KraneShares CSI China Internet UCITS ETF USD [KWEB] | -6.29%
Source: justETF. Data correct as at 01/01/23.
