The FTSE China 25 Index, the index behind the most popular China ETF in the world, recently underwent a methodology change for the better, and China-focused investors should take notice.
Last month, on March 18, FTSE reclassified its country classification of P-chips from Hong Kong to China, meaning this specific type of Hong Kong-listed share class became eligible to be held in the index.
This changes the composition of not only the largest China ETF listed in the United States, the $6.5 billion iShares FTSE China 25 Index Fund (FXI), but also the largest China ETF traded in Europe, the $1.07 billion iShares FTSE China 25 (which trades on five different European exchanges).
I haven’t been the biggest fan of FXI because, aside from its strictly large-cap focus, it had limited scope in terms of which share classes it was eligible or ineligible to hold.
Contrary to what many investors probably thought, FXI didn’t hold the 25 largest Hong Kong-listed Chinese companies. It held the 25 largest Red chips and H-shares traded in Hong Kong. (For a detailed explanation of the various share classes, see IndexUniverse’s China share class guide .)
But now, and all of a sudden, with the inclusion of P-chips, FXI has exposure to sectors like technology and consumer cyclicals, which it previously had no exposure to. MSCI, on the other hand, already included P-chips for a majority of its China indexes.
P-chips are a whole separate group of nonstate-owned Chinese companies listed in Hong Kong. P-chips are companies incorporated outside the mainland and often owned by Chinese entrepreneurs, providing a domestic demand-driven flavor to the mix.
For example, Tencent Holdings and Belle International are two P-chips recently added to FXI. Tencent Holdings, with a market cap of $58 billion, is the largest Internet company in China, while Belle International, with a market cap of $13.6 billion, is the largest shoe retailer in China.
While two companies can hardly make a difference in a broad-based, total market fund, their impact can be significant for a fund that holds only 25 names. Combined, these two companies now make up close to 9 percent of FXI’s total weighting. They also bring a little diversification to a fund that’s heavily dominated by state-owned banks, energy and telecom companies.
Baidu is perhaps the only company remaining from the investable share universe that could be included but isn’t. Baidu, another Internet giant, has a market cap close to $30 billion and is solely listed in the United States as an N-share. N-shares are not eligible for inclusion in FTSE China indexes.
MCHI And FCHI
FTSE’s reclassification also affects FXI’s sister fund, the iShares FTSE China Index Fund (FCHI), which is a total market version of FXI that holds 156 companies. Ironically, the reclassification now gives iShares two almost identical China total-market ETFs.
The iShares MSCI China Index Fund (MCHI) is also a total market fund, which holds 139 companies of mostly the same share classes. Both funds are cap weighted and target large- and midcaps companies, while excluding small-caps. One small difference is that MCHI holds two B-share positions, which combined, make up less than 1 percent of the fund.
The FTSE China 25 Index has become the standard by which Chinese equity sentiment has been compared with (whether it should be is a separate argument). The index is now about as synonymous to Chinese equities as the MSCI Emerging Markets Index is for the emerging markets space.
While FXI is still missing one major company that floats investable shares, I think this change makes the FTSE China 25 Index a better representation of the largest companies in the Chinese market.
Overall, I think FTSE’s reclassification is a positive change that only enhances the attractiveness of funds like FXI.
At the time this article was written, the author had no positions in the securities mentioned. Contact Dennis Hudachek at firstname.lastname@example.org.
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