The quick, steep downturn in Chinese stocks has added a sour new dimension to a debate over when — and whether — U.S. investors should charge into the world's second-largest stock market.
One of the most widely tracked indexes in Asia on Monday entered what's known as a technical correction, a decline from its peak of more than 10%, while the Chinese government unleashed a set of efforts to arrest swift declines in its once-soaring onshore markets.
The declines cast a new spotlight on an ongoing debate over the place of Chinese stocks in the portfolios of retail investors, a tug-of-war that pits the desire to offer exposure to the second biggest economy against fears its fledgling market will give investors and their portfolios whiplash.
The Vanguard Group Inc., the largest U.S. mutual fund company, has been aggressively pushing the argument that better diversification — including into foreign markets and the stocks of smaller companies — will benefit investors.
The firm quietly sought and won access to onshore Chinese stocks known as “A shares” through one of several new cross-border investment programs backed by the government.
Last month,
Vanguard made the surprising announcement that it would
add billions of A shares to its $66.8 billion Emerging Markets Stock Index Fund (VEIEX) and a related exchange-traded fund (VWO). The decision was especially surprising because neither FTSE Russell nor MSCI, the indexes behind the largest emerging-markets funds, have included A shares in their flagship indexes.
TARGETING CHINA A SHARES
Some ETF providers have also been launching funds that specifically target Chinese A shares, including the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR). That fund manages $859 million.
Despite what some see as clear diversification benefits, active money managers have yet to embrace onshore markets and China generally. The most conservative asset allocation funds keep under 1% of their assets in Chinese stocks, while broad emerging-markets funds have about a fifth of their assets deployed in China, according to Morningstar Inc. (China represents 7% of global stock market capitalization, according to World Bank data from 2012, the latest year for which data is available.)
Most of those funds have a very small sliver of exposure to onshore markets, if any at all. Chinese markets are strictly regulated, until recently largely restricting foreign investors. Some foreigners have sought greater regulatory and market reforms before recommending increased investment.
The absence of fund managers meant they missed a historic rally. During the last year, the Shanghai Stock Exchange Composite Index has registered annual gains approaching 150%. But now those funds' lack of exposure is helping funds that aren't invested in onshore Chinese securities. That same index has lost a quarter of its value in the last four weeks.
A number of analysts are recommending that advisers and investors take a wait-and-see approach to onshore Chinese stocks. In an interview Monday, Russ Koesterich, global chief investment strategist for Blackrock Inc., said “the market up until the June peak was characterized by speculative excess,” a reference to China's
margin-debt-using mom-and-pop investors.
“The H shares have significantly outperformed on the way down, but the reality is that market was less subject to speculation,” said Mr. Koesterich, referencing stocks traded by foreigners and fund managers in Hong Kong. “They've performed as you would hope.”
MARKET SLIDE SPREADING
Even funds without exposure to onshore markets may now face the prospect that stock market's slide will spread to other markets or the broader economy. Hong Kong's Hang Seng Index, which includes securities widely bought by fund managers, posted its biggest one-day decline since May 16, 2012 on Monday, 3.18%, pushing it into correction territory.
Chinese authorities have responded to the declines with a multi-pronged attack. On July 4, 21 top brokerages
announced a plan to invest at least 120 billion yuan of their own money in funds of blue-chip stocks. The next day, the country's top securities regulator said the central bank would
financially assist a state-run company that indirectly provides margin loans to investors.
China has already been aggressively using fiscal and monetary policy to stimulate its economy,
slicing interest rates on July 3 for the fourth time since November and relaxing requirements on the level of reserves certain banks must hold.
Despite the slide, Vanguard still expects to start including A shares in its emerging-markets fund in late 2015, a process that's likely to take several months because of the size and complexity of the trade. The company is also hoping to thwart “front runners,” opportunistic traders who try to profit by anticipating market activity.
“We continue to believe that this is an opportune time to enter the China A shares market based on several factors, including increased access to foreign investors, shareholder benefit, liquidity of the market and lower international trading costs,” said David Hoffman, a spokesman for Vanguard, which is based in Valley Forge, Pa., and manages $3 trillion in assets.
