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03 jul 2019

Time to rethink investing in China

chan

Chanchal Samadder, Head of Equities at Lyxor ETF, explains why China merits a standalone allocation in investors’ portfolios.

 A country as big as the United States, arguably as important on the world stage, with the second-largest stock market globally. Yet one whose average allocation among European ETF investors is just 1%.1

It could only be China.

There are historic reasons why China’s enormous market has been under-owned in Europe, including limited market access for foreign investors, a lack of data transparency and poor reflection in global benchmark indices.     

But that’s all changing. China is liberalising its market and opening up to foreign investors, while more and more Chinese companies now operate internationally, providing goods and services across the globe. Today China is the largest economy in the world when measured by GDP at Purchasing Power Parity (PPP), and by 2030 will be the largest in nominal GDP terms.2 China’s equity market is already the second largest in the world by market capitalisation and share of global profits, and the largest when measured by the number of listed companies. This is evidence that China is a large, mature and resilient market which is too important to be diluted with other emerging markets.

GDP based on PPP* as share of world (%)3

US China PPP chart

To reflect China’s growing importance and interest for investors, MSCI and FTSE Russell, two index providers, have been adding mainland China equities into their benchmark indices. A third, S&P Dow Jones Indices, will start doing the same in September 2019.

As China’s global role expands and the biggest indices change their weightings, we believe that it’s time for European investors to rethink their approach to this Asian superpower.

Welcoming China’s liberalisation

The changes to benchmark EM indices mean that many more European investors will soon find their money invested in Chinese companies, such as tech giants Baidu, Alibaba and Tencent (known as the ‘BATs’: the equivalent of the USA’s ‘FAANGs’ of Facebook, Apple, Amazon, Netflix and Google).

For investors, it’s good news when an economy opens up after market liberalisation. It means that Chinese companies can benefit from international capital flows, and that global investors can benefit from the success of those companies. China’s tech companies are real digital disruptors, for example, and many investors want to be part of this.

However, while index providers catch up with China’s increasing importance, a question arises: is our approach to China all wrong? Should such a major global player be treated as part of the ‘emerging markets’ at all?

As markets change, our approach must change too

‘Emerging markets’ was coined as a term in 1981, when the world looked very different. Even then, it grouped together a range of heterogeneous countries which shared certain broad characteristics, such as being in the process of market reform.

Today, EM indices still mix very different countries, from economic powerhouses like China to others with very different sizes and drivers of return, such as South Africa, Thailand and Mexico.

As markets have evolved, investors’ approaches to them must evolve too. In our view, it makes sense to think of major economies such as China as separate allocations, rather than bundling them together with other ‘emerging markets’.

Think of China as a standalone allocation

As a provider of ETFs, we believe in their power to help express investment views in a clean and simple way.

Our latest EM ETF aims to provide extra choice for investors grappling with the China question: it takes the universe of emerging markets and removes China entirely, following our principle that the country should now be considered as a standalone investment.

MSCI EM ex China vs. MSCI EM – country breakdown4

MSCI EM ex China vs. MSCI EM – country breakdown

An investor can use this ETF to gain a broad exposure to the world’s most dynamic developing countries, and still have the freedom to make an independent allocation to the Chinese powerhouse. This offers the flexibility to dial China exposure up or down in a simple way, without having to buy or sell other EMs at the same time. It can also be used by an investor taking the opposite view on China, wanting to specifically avoid Chinese stocks while still achieving exposure to other EMs.

We’re proud to be the first to bring this exposure to the European ETF market, as we believe it will become an important benchmark for EM investors. Whatever your view on China and emerging markets, for 2019 and beyond, it might make sense to rethink how you invest in the Asian superpower.

Find out more about the Lyxor MSCI Emerging Markets Ex China UCITS ETF

1Lyxor International Asset Management, Bloomberg. Data as at 28/03/2019. Data refers to European UCITS ETF market.
2Source: IMF, World Economic Outlook, October 2018.
3Source: IMF, World Economic Outlook, October 2018. Data period from 1980 to 2023, of which 2019 to 2023 data is forecast. *PPP=Purchasing Power Parity.
4Source: MSCI, as at 31/05/2019.

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