China A-Shares offer benefits to global investors, finds Vanguard

May 3rd, 2017 | By | Category: Equities

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Investors can benefit from including China A-Shares as part of a globally diversified portfolio, regardless of China’s short- to medium-term performance, according to research undertaken by ETF provider Vanguard.

Peter Westaway, Vanguard chief economist, Europe.

Peter Westaway, Vanguard chief economist, Europe.

In a paper titled “Navigating the transition: China’s future at a crossroads”, Vanguard examines the future of the Chinese economy, and the implications for investors. The study discusses the balancing act between China’s near term economic and social stability, and its long-term sustainability, while highlighting the potential difficulties in navigating financial risk and external uncertainty.

While Vanguard is relatively optimistic on the short- to medium-term performance of the Chinese economy, the firm asserts that exposure to China is important for global investors, regardless of whether China’s economy experiences a ‘hard landing’ on account of its policy actions. In particular, Vanguard believes that as part of a globally diversified portfolio, exposure to A-shares will benefit investors from both a diversification and return perspective.

Peter Westaway, Vanguard chief economist, Europe, commented: “Despite some fears, we believe there is an above 50% chance China will avoid a crash or “hard landing” as the economy re-balances from export-based manufacturing to service and consumption, and indeed that there is an above 50% chance the Chinese government will successfully implement structural reforms and avoid stagnation or instability. Most importantly, we believe investing in China enables investors to gain exposure to a growing share of world GDP, and the associated diversification benefits in a global portfolio, regardless of future growth scenarios.”

As of January 2017, China had the world’s second largest equity market with $6.6 trillion in total market capitalization; the A-share market total capitalisation has grown by 480% over the last decade. Additionally, the country boasts the third largest bond market ($9.2 trillion). Historically a market dominated by government bonds, credit bonds now account for about 36% of outstanding bonds (compared with 9% in 2007).

Westaway continued: “We see China’s equity market as a critical diversifier. A-shares in particular have a low correlation with the rest of the global equity market. In the long run, equity market return also has a low correlation with economic growth and overall, A-shares as a source of return and diversification in global portfolios should benefit long-term investors, independent of whether or not China experiences a ‘hard landing’.”

In mid-2015 Vanguard changed the underlying index for its Vanguard FTSE Emerging Markets ETF (NYSE: VWO), currently holding over $70bn in AUM, from the FTSE Emerging Markets Index in favour of the FTSE Emerging Markets All Cap China A Inclusion Index, in a move that saw the introduction of China A-Shares for the first time.

While the proportion of China A-Shares within the total fund remained relatively small at 5.6%, Vanguard Chairman and CEO Bill McNabb, commenting at the time, highlighted the benefits to investors: “As the first major emerging markets fund to add exposure to China A-shares, the fund will benefit investors with more diversification, deeper emerging markets exposure, and greater access to the growth potential of Chinese equities.”

Due to the index change, several of the fund’s top ten holdings are currently comprised of A-Shares, including China Construction Bank, Industrial & Commercial Bank of China, and Bank of China.

The fund has a total expense ratio (TER) of just 0.14%, making it one of the lowest cost means of accessing emerging market equities.

While the European version of the fund, the Vanguard FTSE Emerging Markets UCITS ETF (LON: VFEM), still tracks the original FTSE Emerging Markets Index, it is likely at some point to follow in its US counterpart’s footsteps. VFEM has a TER of 0.25%.

The authors of “Navigating the transition: China’s future at a crossroads” are Qian Wang, Jessica Mengqi Wu, and Zoe Bryn Odenwalder.

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