The equity market in China has been a popular investment segment for the last decade. The ETF world has recognized this and built out numerous products to invest in broad based Chinese equities, sectors and themes. However, a closer look at the 22 ETPs in this space reveals a bit of a ghost town when it comes to investor interest. Of the 22 listed China ETPs, 14 of the products have less than $60 million in assets under management.
Even more ghostly is that 32% of China ETPs have less than $10 million in assets. This gap between product offerings and investor interest is troubling. It is reminiscent of the massive real estate developments in China that exist virtually unoccupied today. Why has there been a disconnect between product providers and investor interest? Is this area ripe for product closures? What China equity ETPs look promising? Let’s examine these questions and more.
The last five years have not been kind to investors in Chinese equities. This hasn’t stopped ETPs from launching though as 15 of the 22 China equity ETPs were launched during this period. China has dramatically underperformed the S&P 500 ETF as measured by FXI, the iShares FTSE China 25 Index Fund. FXI is by far the largest China focused ETP with over $4.7 billion in assets. Here’s the five year performance comparison between the SPDR S&P 500 ETF (SPY) and FXI. The difference between the two funds is a massive 128 percentage points.
Some China equity aficionados will argue correctly that FXI isn’t a diverse representation of the equity market in China. The index FXI seeks to track is dominated by large cap companies within certain sectors. Taking a step back, one can see some variance in returns across several China ETPs focusing on unique segments of the Chinese market. Here’s the same five year performance period comparing FXI to a more diversified China equity ETF, the PowerShares Golden Dragon ETF (PGJ), and a small cap focused China ETF, the Guggenheim China Small Cap ETF (HAO).
Note that these Chinese market segment ETFs double and even more than triple the return of FXI over the last five years. Even so PGJ, the best performing ETF in the comparison, has less than half the total return of SPY in that time period. In short while there are more attractive value propositions than others within the China ETP universe, all China ETPs have significantly lagged the returns delivered by investing in broad based U.S. equities over the last five years. Could that return set be ready to change?
Taking a look at the last year, it appears the return set for China equity investors is at least becoming more competitive. Here’s the one year performance comparison of SPY to FXI, PGJ, and HAO.
This one year comparison chart is a better performance period for those following the China growth story. FXI and HAO are still trailing SPY but are at least in the same performance ballpark. This under-perfomance has likely been behind the $1.6 billion of outflows FXI experienced over the last year according to fund flow data from ETF.com. Oddly enough PowerShares’ PGJ, despite almost doubling SPY’s one year return, has also experienced net fund outflows over the last 12 months.
Pruning China Equity ETPs?
It appears investors have a long term memory when it comes to China equity performance, a trend which could signal trouble for ETP viability. Basic fund economics on ETPs with little to no investor interest point to at least 30% of China ETPs being candidates for closure or conversion. Barring a longer term streak of outperformance from Chinese equities, this product set seems ripe to be pruned. There will be plenty of ETPs that succeed however. The ten largest China ETPs seem likely to continue on as they all have at least $50 million of assets under management and expense ratios that make fund economics less taxing for product providers. Here’s a list of those ten ETPs sorted by asset size as displayed by ETF Database.
In addition China ETPs that access the China “A” share market seem likely to be survivors due to the unique exposure they provide. These funds are relatively new to the U.S. marketplace and are still relatively small in size with three of the five choices under $6 million in assets.
The ghostly feel of China equity ETPs can be attributed to a variety of factors: tepid Chinese equity performance, a rush to capture ETF marketshare by product providers and even the robust performance of the U.S. markets over the last five years. This sleepy ETP market segment could turn on a dime however which is why product providers and investors remain interested in having a presence in the space. Going forward it will be interesting to see if China can live up to the “build it and they will come” attitude of today’s China equity ETP product set.