Emerging market (EM) equities tend to be under-represented when it comes to global market cap-weighted ETFs. For example, just 10.60% of the Vanguard FTSE Global All Cap ex Canada (TSX:VXC)(VXC) is held in EM equities. Others like the iShares MSCI World Index ETF (XWD) exclude them altogether.
With valuations in popular markets like the U.S. increasingly stretched, aspiring value investors who don't mind taking on higher volatility may be looking towards emerging market countries like China for more favorable growth opportunities over the next decade.
For example, China Shanghai Stock Exchange recorded a daily price-to-earnings (P/E) ratio of 13.61 as of February 13th, compared to as of February 13th, compared to 19.17 for the U.S. S&P 500 index. This comes after a decade of double-digit U.S. market outperformance that leaves many wondering if a repeat for 2023 onwards is sustainable.
Another thematic catalyst currently playing out this year is the "China Reopening". Years of severe COVID-19 restrictions, credit risk in the real estate sector, and political crackdowns on the tech sector have left Chinese equities in a unique position to benefit from a potential rebound.
Let's look at some ETFs I found via the NEO ETF screener that could potentially benefit from this trend.
BMO (TSX:BMO) MSCI China ESG Leaders Index ETF (TSX:ZCH) (ZCH)
The most popular Canadian-listed Chinese equity ETF right now is ZCH, which currently sits at around $149 million in assets under management (AUM). ZCH is unique in that it implements an environmental, social, and governance (ESG) screener by tracking the MSCI China ESG Leaders Index.
The index primarily relies on MSCI's ESG ratings for large and mid-cap Chinese equities by excluding companies that earn "significant revenues" from tobacco, gambling, weapons, nuclear power, and those involved in "severe business controversies". The result is a portfolio of 159 holdings with an average MSCI ESG score of 5.8, which translates to an "A" rating.
iShares China Index ETF (TSX:XCH) (XCH)
Investors not looking to prioritize ESG considerations can opt for XCH, which offers concentrated exposure to 50 of the largest Chinese equities via the FTSE China 50 Index. This ETF provides exposure via an "ETF of ETFs" structure, with 99.93% of its portfolio held in the U.S. listed iShares China Large-Cap ETF (FXI). While simple, this approach might not be ideal.
The primary issue with XCH is tax efficiency. Due to its structure, there are two layers of foreign withholding tax imposed. The first one is at the U.S. ETF level from the underlying Chinese equities. The second is at the Canadian ETF level from the underlying U.S. ETF. This, along with the ETF's high 0.86% expense ratio can result in significant drags on performance.
CI ICBCCS S&P China 500 Index ETF (TSX:CHNAb) (CHNA.B)
Investors looking for a broader approach to Chinese equities may like CHNA.B, which tracks the S&P China 500 Index. With this ETF, CI Global Asset Management opted to include all Chinese share classes, including A-shares and offshore listings. The end result is a larger portfolio of securities that is less top-heavy and less concentrated in certain sectors like financials and consumer discretionary.
Unlike XCH, CHNA.B also holds its securities directly, which results in only one layer of foreign withholding tax. I'm a bit surprised that the ETF has only attracted $48 million in AUM since its debut in August 2018, given its more tax-efficient structure, higher degree of diversification, and lower expense ratio (0.63%) than XCH. All in all, CHNA.B looks like a good way to passively index Chinese equities.
Mackenzie China A-Shares CSI 300 Index ETF (NLB:QCH)(QCH)
Last, but certainly not least, is QCH, which is the only NEO-listed ETF on this list. As its name suggests, QCH tracks the CSI 300 Index, a market cap-weighted index of the top 300 stocks traded on both the Shanghai and Shenzhen stock exchanges. The popularity of this index within China helps QCH maintain good liquidity with its underlying holdings and lower portfolio turnover.
QCH uses a rather unique "ETF of ETFs" structure where it wraps an underlying Hong Kong-listed ETF, the China AMC CSI 300 Index ETF (3188 HK / 83188 HK). As of February 22nd, QCH has attracted $26 million in AUM and charges a 0.70% expense ratio. Given the different indexes between QCH and CHNA.B, investors could possibly use them as tax-loss harvesting pairs.
This content was originally published by our partners at the Canadian ETF Marketplace.