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Why You Should Incorporate China ETF Exposure

This article was originally published on ETFTrends.com.

Investors may not be properly allocated to international markets, especially toward China, the second largest economy in the world. Nevertheless, with targeted exchange traded funds, anyone can shore up a portfolio that is underweight this emerging market.

On the recent webcast, How to Prepare for MSCI’s China Change, Eric Legunn, ETF Strategist for DWS Asset Management, outlined a number of reforms China has made to open up and standardize its financial markets. For example, in 2016 the new accounting law, China Generally Accepted Accounting Principles, was implemented, bringing China's accounting standards in line with globally accepted norms. These reforms have helped attract global investors to this emerging market segment.

As investors look for China exposure, many have turned to broad emerging market ETFs to gain diversified exposure to this emerging country. Todd Rosenbluth, Director of ETF & Mutual Fund Research for CFRA, pointed out that popular emerging market ETFs allocate about 30% to China. Looking ahead, China's exposure may even increase as MSCI indices are in the early stages of adding China A-shares into their portfolio construction process.

"MSCI emerging markets indices are also widely followed by actively managed mutual funds," Rosenbluth added. "CFRA expects continued demand for China A-shares stocks and funds that offer direct exposure."

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While many of the popular emerging market funds include China exposure as one of their top country holdings, most funds access Chinese companies through H-shares or Hong Kong-listed stocks or N-Shares that are traded on the New York Stock Exchange. However, despite sharing a country of origin, the share class does not move in lockstep with Chinese domestic markets.

China A-shares, on the other hand, specifically cover domestic Chinese company stocks trading on China’s mainland exchanges in Shanghai and Shenzhen. Chinese A-Shares are a specific class of equity securities issued by Chinese companies and denominated in RMB. Under Chinese regulations, foreign investors may access A-Shares if they are a designated foreign institutional investor or gained access through either the Qualified Foreign Institutional Investor (QFII) or a Renminbi Qualified Foreign Institutional Investor (RQFII) programs.

Additionally, investors may take targeted exposure to Chinese equity moves through China country-specific ETFs. However, Rosenbluth warned potential investors should look under the hood as not all China ETFs are constructed equally. Many of the popular China H-shares ETF plays have a large tilt toward the financial sector or Chinese state-owned banks. On the other hand, relatively newer options may include a heavier information technology tilt to reflect the recently growing segment among internet names.

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David Garff, President of Accuvest Global Advisors, pointed out that China is among Accuvest's top ranked markets as this Asian economy ranks first among fundamental factors and momentum factors - China exhibited attractive long term earnings growth, percent change in PMI, return on equity, growth to price-earnings ration and mid-term returns. However, Garff warned that China was ranked less favorably due to greater risk exposure - the market showed less satisfactory current P/E versus 5-year average, high political risk, elevated price-to-cash earnings and percent expected change in foreign exchange moves.

Potential investors who are interested in taking a direct look into China's market have a number of options available. Sean Edkins, Director and Head of ETF Sales and Strategic Partnerships for DWS Asset Management, outlined several options at DWS, including the Xtrackers MSCI All China Equity ETF (CN) , Xtrackers CSI 300 China A-Shares ETF (ASHR) , Xtrackers CSI 500 China A-Shares Small Cap ETF (NYSEArca: ASHS) and Xtrackers CSI 300 China A-Shares Hedged Equity ETF (ASHX) .

ASHR is the largest U.S-listed A-shares ETF and targets the 300 largest and most liquid stocks in the China A-shares market.

ASHS tracks more mid-sized Chinese A-shares, includiing Chinese A-shares taken from the China Securities 500 Index, stocks listed in Shanghai and Shenzhen.

CN has a broader portfolio, allowing investors to track mainland Chinese stocks, with a 33.8% position in ASHR and 5.4% in ASHS, and the fund holds Chinese stocks listed in the U.S. and Hong Kong.

Lastly, ASHX tracks the CSI 300 USD Hedged Index, which is designed to provide direct access to China A-shares while diminishing the negative effects of a depreciating Chinese yuan currency against the U.S. dollar – a weaker foreign currency means that returns are also lowered when converted into U.S.-dollar-denominated returns. The ETF basically acts like a hedged version of ASHR.

Financial advisors who are interested in learning more about China’s markets can watch the webcast here on demand.