China Index Fund: A Guide To Investing In China's Future

China is the second-largest economy in the world and has a nominal GDP of nearly $12 trillion as of 2017, growing at about seven percent. Given the country's growing influence, international investors are increasingly interested in its stock markets. China's economy is best known for its manufacturing sector, which surpassed the United States as the largest in the world in 2010. The easiest way to invest in the Chinese stock market is through a broad market index, which can be done at a low cost by using ETFs. There are 12 indices on the Chinese stock market that are tracked by ETFs, and the total expense ratio (TER) of ETFs on these indices ranges from 0.19% p.a. to 0.88% p.a.

Index funds explained

Index funds are a type of mutual fund or exchange-traded fund (ETF) that contains all (or a representative sample) of the securities in a given index, allowing investors to closely compare the performance of that benchmark. Index funds are a diverse, simple, and inexpensive investment option. They are also easy and convenient, making them a popular choice for investors.

When you invest in an index fund, you gain access to a diverse range of securities in a single fund, reducing overall risk through broad diversification. By investing in multiple index funds that track different indices, you can create a portfolio aligned with your desired asset allocation. For example, you might allocate 60% of your funds to indexed equity funds and 40% to indexed bond funds.

The most significant advantage of index funds is their superior performance compared to other types of funds. This is primarily due to their low management fees, as they are passively managed. Instead of having a manager actively trading, index funds simply duplicate the portfolio of a designated index. As a result, they also benefit from lower transaction costs.

Additionally, index funds have tax advantages. They generate less taxable income for their shareholders because they trade securities less frequently than actively managed funds. Furthermore, when selling a particular security, index funds can choose from various lots to minimise capital gains tax.

• Start with a classic three-fund portfolio, including two stock funds and one bond fund.
• Choose simple, low-cost index funds.
• Select companion funds judiciously to add variety to your portfolio.
• Avoid over-diversification, as it can increase costs and diminish returns.
• Stay the course and maintain a long-term perspective, even during market downturns.

Index Funds in China

China is the second-largest economy globally, with a nominal GDP of nearly $12 trillion in 2017 and a growth rate of about seven percent. Its stock market offers diverse growth opportunities, attracting international investors.

One way to invest in China is through index funds or ETFs. These funds provide exposure to a range of Chinese stocks or specific sectors, such as consumer goods or technology. Here are some popular China index funds and ETFs:

• IShares MSCI China ETF (NYSE: MCHI)
• Vanguard Total China Index ETF (3169)
• IShares FTSE/Xinhua China 25 Index ETF (FXI)
• KraneShares Bosera MSCI China A 50 Connect Index ETF (KBA)
• Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR)

China's economic growth

China's strong growth has been based on investment and export-oriented manufacturing, and the country is the world's largest manufacturing economy and exporter of goods. However, exports as a percentage of GDP have steadily dropped to around 20%, reflecting a decreasing importance to the Chinese economy. China's manufacturing has been transitioning towards high-tech industries such as electric vehicles, renewable energy, telecommunications, and IT equipment, and services have also grown as a percentage of GDP.

China's economic reforms have greatly increased the economic role of the banking system, and the country has the world's largest total banking sector assets. The financial sector is mostly state-owned and governed, with the People's Bank of China and the Ministry of Finance playing chief roles in financial and fiscal control.

China's growth has been fuelled by its large and low-wage labour force, which was the world's largest as of 2021, with 791 million workers. The country has also sustained growth due to its export relations and its manufacturing sector. In 2020, China was the only major world economy to experience GDP growth, with a 2.3% increase.

However, China's economic growth is slowing down in the 2020s as it faces challenges such as a rapidly ageing population, higher unemployment, and a property crisis. There are also concerns about the accuracy of China's economic data, with some analysts arguing that official figures overstate the country's economic growth.

To address these challenges and reduce imbalances, China needs to shift from manufacturing to high-value services, from investment to consumption, and from high to low carbon intensity. Structural reforms are required to reinvigorate the shift towards more balanced, high-quality growth.

How to invest in China from outside China

Investing in China from outside the country can be done through index funds or exchange-traded funds (ETFs). These funds allow investors to gain exposure to Chinese markets without directly purchasing stocks.

Step 1: Understanding Index Funds and ETFs

Index funds are a type of mutual fund or ETF that holds a diverse selection of securities, such as stocks or bonds, to closely track the performance of a specific market index. ETFs are similar but can include other assets like currencies and tend to be more flexible in terms of buying and selling.

Step 2: Evaluating the Risks and Benefits

Investing in China comes with certain risks. The country's economic growth rates may be overstated, and there are concerns about corporate governance and political stability. Additionally, the Chinese stock market is heavily influenced by retail investors, making it more volatile than some other markets.

However, China's economic growth, technological advancements, and consumer-driven economy present potential opportunities.

Step 3: Choosing the Right Investment Vehicle

When considering how to invest in China, you can opt for broad-market index funds or ETFs that provide exposure to the overall Chinese market. Alternatively, you can choose sector-specific funds focused on technology, healthcare, or real estate.

Some popular China ETFs include:

• IShares FTSE/Xinhua China 25 Index ETF (FXI)
• IShares MSCI China ETF (MCHI)
• SPDR S&P China ETF (GXC)
• Xtrackers Harvest CSI 300 China A-Shares Fund (ASHR)
• KraneShares CSI China Internet ETF (KWEB)

Step 4: Opening a Brokerage Account

To invest in Chinese stocks or ETFs, you will need to open a brokerage account with a platform that offers access to Chinese markets. Make sure to research and compare different brokers to find one that suits your needs and requirements.

Tips for Successful Investing:

• Diversify your portfolio: Avoid putting all your eggs in one basket. Consider allocating a portion of your portfolio (e.g., 10%) to Chinese investments as part of a broader emerging markets strategy.
• Be cautious with individual stock picking: The risks of individual stock picking are generally higher, especially in emerging markets like China.
• Consider the long-term potential: While short-term fluctuations may occur, focus on the long-term growth prospects of the Chinese economy and its impact on your investments.

In summary, investing in China from outside the country involves understanding the risks and opportunities, selecting the right investment vehicles, and carefully choosing a brokerage platform that aligns with your investment goals and strategy.

Best China ETFs

China exchange-traded funds (ETFs) are a great way for investors to geographically diversify their portfolios by investing in a basket of companies based in the world's second-largest economy. There are several types of China ETFs, including equity, fixed income, and currency asset classes. Some focus on the total China market, while others focus on company size or specific sectors like technology, healthcare, and real estate.

IShares MSCI China ETF

This ETF provides exposure to Chinese companies listed in different exchanges, including A shares, H shares, and US ADRs. It is listed on two exchanges: NASDAQ (MCHI) and Hong Kong Stock Exchange (2801). The expense ratio for the NASDAQ-listed ETF is 0.58%, while the Hong Kong-listed ETF has a lower expense ratio of 0.2%.

IShares Core CSI 300 ETF

The iShares Core CSI 300 ETF tracks the CSI 300 index, giving investors exposure to large and mid-cap stocks listed on the Shanghai and Shenzhen Stock Exchanges. It is listed on the Hong Kong Stock Exchange in HKD, USD, and RMB, so investors need access to the Hong Kong markets to invest.

IShares MSCI China A ETF (CNYA)

The iShares MSCI China A ETF is one of the best-performing China ETFs, providing exposure to the MSCI China A Index. It is listed on the Cboe BZX exchange in the US and has an expense ratio of 0.60%. The fund includes a diverse range of stocks, with financials, consumer staples, and industrials as the top three sectors.

KraneShares Bosera MSCI China A 50 Connect Index ETF (KBA)

The KraneShares ETF targets the MSCI China A 50 Connect Index, which includes 50 large-cap stocks listed in Shanghai and Shenzhen. It has an expense ratio of 0.56% and focuses on a blend of value and growth stocks.

Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR)

The Xtrackers Harvest CSI 300 ETF seeks to track the CSI 300 Index, comprising 300 large and mid-cap China A-Share stocks listed on the Shenzhen or Shanghai Stock Exchange. It is one of the oldest ETFs providing direct exposure to these exchanges and has a high trading volume. The expense ratio for this ETF is 0.65%.

KraneShares CSI China Internet ETF (KWEB)

The KraneShares CSI China Internet ETF provides exposure to publicly traded internet stocks based in China. It includes stocks listed on the Hong Kong Stock Exchange, NASDAQ Stock Exchange, and New York Stock Exchange.

Global X China Electric Vehicle and Battery ETF

This ETF provides exposure to China's growing electric vehicle market by tracking the Solactive China Electric Vehicle and Battery Index. It is listed on the Hong Kong Stock Exchange in HKD and USD.

Global X China Clean Energy ETF

The Global X China Clean Energy ETF offers broader exposure to China's clean energy sector by tracking the Solactive China Clean Energy Index. It is also listed on the Hong Kong Stock Exchange in HKD and USD.

KraneShares CICC China 5G & Semiconductor ETF (KFVG)

This ETF provides exposure to the semiconductor industry in China, which has seen increased demand since the pandemic. It is listed on the New York Stock Exchange.

China Consumer ETF (2806)

The China Consumer ETF gives investors exposure to brands serving the Chinese consumer market, including well-known companies like Kweichow Moutai and Midea. It is listed on the Hong Kong Stock Exchange in HKD and USD.

Risks of investing in China

Investing in China comes with a unique set of risks that investors should be aware of before committing capital. Here are some of the key risks associated with investing in China:

Political and Regulatory Risk

The Chinese Communist Party's economic reforms have opened the country to foreign investment and spurred impressive economic growth. However, the country's political landscape poses risks for investors. Domestic political instability, regional political unrest, and protectionist sentiment in the Western world can all impact the investment climate in China. Additionally, the Chinese government's tight control over its biggest companies can lead to sudden regulatory changes that can disrupt growth prospects, as seen in the education sector and with companies like Didi Global.

Economic Risks

China's economy is expected to continue growing, but there are concerns about the sustainability of this growth. Analysts point to potential issues in the real estate market, government debt, especially at the local level, and the decline in foreign direct investment (FDI). The trade wars between the U.S. and China have also caused uncertainty, and China will need to make significant changes to ensure long-term sustainable growth.

Accounting and Insider Trading

Chinese accounting standards and regulations differ significantly from those in the U.S. Chinese companies follow the Chinese Accounting Standards (CAS) or Chinese Generally Accepted Accounting Principles, which are not the same as U.S. GAAP. This makes it challenging for investors to accurately assess the financial health of Chinese companies. Additionally, insider trading is a persistent issue in China, despite regulations banning large shareholders from trading before companies release financial reports. Academic studies suggest that Chinese executives still make well-timed and lucrative stock transactions, indicating that insider trading laws are not effectively enforced.

Geopolitical Risk

The contentious relationship between the U.S. and China adds a layer of risk for investors. For example, an executive order signed by former U.S. President Donald Trump banned U.S. investors from investing in Chinese companies with alleged ties to the Chinese military, leading to the delisting of certain Chinese stocks from U.S. exchanges. Geopolitical issues can also impact China's economic recovery, as seen with the COVID-19 pandemic.

Frequently asked questions