What’s Inside Your Emerging Markets Fund

Shareholders of large emerging market ETFs and mutual funds already have meaningful exposure to China, but the weightings may rise significantly in the second half of 2015, depending on what benchmark the products seek to replicate or outperform.

Vanguard has announced that it will be transitioning by the end of 2015 to a new FTSE index for benchmarking for Vanguard Emerging Markets that will ultimately scale up to a 5.6% weighing in China A-shares. Meanwhile, MSCI last week announced that it is not yet ready to include China A-shares in its two popular MSCI Emerging

Markets indices used by iShares MSCI Emerging Markets and iShares Core MSCI Emerging Markets. MSCI cited ongoing efforts needed to improve the accessibility to the market by its institutional clients.

Why is additional exposure to China important? The answer is that China accounts for 20% of global trade, is the world’s largest manufacturer, and has more than 2,000 companies listed on exchanges.

China A-shares are equity shares in mainland China companies that are traded on the Shanghai and Shenzhen stock exchanges and are available only to qualified foreign investors through regulated systems. In late 2014, China began providing additional yet limited access to this market, though there are quotas and regulatory approval for asset managers. Currently, iShares and Vanguard access China through H-shares of

Chinese companies such as China Mobile and Tencent Holdings that trade in Hong Kong.

Vanguard said that it recently received a $1.6 billion initial quota for China A-shares for use in its funds, which the company believes will provide exposure to China’s largest issuers and a level of diversification that isn’t otherwise available in the market. Vanguard plans to apply quarterly for additional quotas and increase its exposure to China A-shares as it transitions to a new FTSE index. However, with $69 billion in assets currently in Vanguard Emerging Market share classes, we think investors will need to watch for how well the fund can keep to its planned schedule as it continues to grow its exposure to China.

In ranking equity mutual funds and ETFs, S&P Capital IQ looks beyond past performance metrics and reviews the portfolio’s holdings from a valuation and risk perspective. As such, what’s inside the fund is particularly important. 

For the past year, the biggest difference between Vanguard and iShares emerging market ETFs was the exclusion of South Korea in the Vanguard products. While iShares ETFs largest country exposure was recently to China, South Korea (15%) was the second largest. However, last week’s announcement by MSCI to hold off including China A-shares until it sees improvement in quota availability, capital mobility and beneficial ownership of investments provides another meaningful difference for investors to consider.

Follow me on Twitter at @ToddSPCAPIQ

Subscribe to Insights