Over the past decade, China has evolved from a fringe emerging market best captured via extraterritorial proxies like Hong Kong to a hub of the global investment universe.
Today, your clients probably have significant exposure to Mainland China whether they know it or not. The important thing is making sure they are comfortable with what they have and, if so, tailoring their holdings to support better outcomes.
You know your clients. You know what motivates them. Some will reject on moral or political grounds the suggestion that China needs to be part of their investment framework, much as other clients reject fossil fuels or stem cell stocks in the portfolio. In that case, you provide value by screening out assets tied too closely to Beijing.
However, that screening process becomes more difficult when the same clients want to make sure they capture the most dynamic economic conditions on the planet . . . even if that means chasing opportunities across hot-and-cold trade war walls. China is doing relatively well now from a pure economic perspective.
The COVID contraction there was brief and the domestic economy is once again growing at a 3.2% annualized rate. While plenty of social stress points and geopolitical questions remain, these numbers are still compelling against a global environment Federal Reserve Chairman Jerome Powell recently called "the worst in our lifetime."
And even if we simply want exposure to the world's emerging markets as a way to diversify away from domestic risks, China now looms so large on the investment screen that it's very difficult to ignore on anything like an efficient basis.
A few years ago Mainland China was only a thin slice of market-weight emerging markets funds, leaving investors walled off from the country and forcing those who wanted access into proxies traded in Hong Kong. Now, thanks to democratized access, Mainland China sprawls across a staggering 35% of EEM . . . as big a footprint as South Korea, Taiwan, India and Brazil combined.
If clients insist, removing China from of those portfolios requires a little heavy lifting but it can be done with country-specific funds. Of course there's an immediate sacrifice involved because Shanghai on its own is up 6% YTD while EEM is still down 3%. Taking Shanghai away pushes emerging markets investors back into correction territory over the last seven months.
Is that an acceptable sacrifice? Only your clients can tell you. But if they simply want exposure to the global economy, eliminating one of the most dynamic markets on the planet will have a significant negative impact on performance.
On the other hand, if there are no clear external considerations, a dedicated allocation to China currently looks compelling from a tactical perspective. The challenge here is selecting the right fund to accurately reflect the true dynamism of that economy.
While the first wave of broad-based China funds led the way in opening up the mainland market, they remain overweight the export-oriented manufacturers as well as utilities and financial institutions that are often state-owned enterprises. As a result, their results have suffered as rising trade barriers cut key constituents off from foreign customers and foreign capital.
Even more recent funds like MCHI retain a persistent overweight in mature state-dominated industries like telecommunications, where results have not kept up with the Shanghai market as a whole. The real dynamism in China right now is elsewhere as the country continues its strategic pivot from export to domestic consumption.
Darshan Blatt, whose firm Glovista Investments launched a China sector rotation strategy late last year, thinks he can beat Shanghai by 3 percentage points a year simply by overweighting the right themes. As he puts it:
As China’s economy evolves, growth opportunities are becoming more narrowly concentrated in specific sectors. In shifting towards a consumption-oriented economy, consumer-driven sectors are most attractive given the impact of wage growth, migration into cities, and an expansion of internet connectivity. China’s enormous middle class, larger than the US population, spends more time and money on goods and services, which span across leisure, retail, healthcare, and technology segments of discretionary sectors.
He uses Global X China Sector ETFs to achieve that tactical exposure. These funds segment the Shanghai market just like U.S. sector portfolios, grouping roughly 700 Chinese stocks by cyclical role and weighting them according to their footprint in the mainland economy.
Much like what we've seen in the U.S. market, returns are "broadly distributed" to reflect COVID impacts and the lingering dislocations of the recent trade war. Technology (CHIK) and healthcare (CHIH) have soared more than 40% YTD to reflect investors' conviction that these will be the companies to alleviate the pandemic and support a new social framework in the meantime.
As in the United States, investors are also keenly aware of the essential role purveyors of packaged food, personal care products and other consumer staples (CHIS) play. Likewise, in a quarantine environment, home delivery in China first became ubiquitous and then a new habit, driving the electronic commerce stocks that dominate the Global X Consumer Discretionary ETF (CHIQ).
Focus on these four sector funds and your clients would have beaten broad China portfolios as well as most diversified U.S. and global strategies. The Chinese consumer is where the sizzle is now. Ignore at your own risk.
