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 (NYSEArca: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 (NYSEArca:FCHI), which is a total
market version of FXI that holds 156 companies. Ironically, the
reclassification now gives iShares two almost identical China
The iShares MSCI China Index Fund (NYSEArca: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
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
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
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