If you’ve followed the news over the last month or so, you’re aware that China’s stock market has been on a wild ride. The Shanghai Composite Index (companies traded in Mainland China) is down more than 25% in the last 2 months, but still up almost 70% over the last 12 months.* This quick run-up in prices followed by the sudden drop, along with the Chinese government’s response, is cause for concern on several levels.
How the Chinese stock market affects your portfolio
If you’re invested in an emerging markets stock fund or a total international stock fund, you have some exposure to China. In this article, we’re going to focus on the funds we typically recommend to gain access to emerging markets stock: low-cost, passively managed funds. This includes Vanguard FTSE Emerging Markets ETF (VWO), DFA Emerging Markets Core Equity (DFCEX), Schwab Emerging Markets Equity ETF (SCHE), and Fidelity Spartan Emerging Markets Index (FPEMX).
Today, none of these funds include China A Shares, the companies that trade in mainland China. All 4 of these funds get their exposure to China through companies that trade primarily in Hong Kong. The companies that trade in Hong Kong have also been affected by the events in the Mainland, but to a lesser extent.
The MSCI China index that primarily tracks the Hong Kong traded companies lost about 15%** over the last two months, as compared to the 25% loss for the Shanghai Composite Index. The MSCI China index also didn’t enjoy the massive gains that the mainland-traded Chinese companies racked up over the last year. The MSCI China index is still up just over 4%** for the last 12 months (vs. 70% for the Shanghai Composite Index).
Each of these funds includes China in varying weights.
- Vanguard FTSE Emerging Markets ETF (VWO): 28%
- (Source: FTSE Data as of 6/30/2015)
- DFA Emerging Markets Core Equity (DFCEX): 17%
- (Source: Dimensional Fund Advisors as of 6/30/2015)
- Schwab Emerging Markets Equity ETF (SCHE): 27%
- (Source: Morningstar as of 8/6/2015)
- Fidelity Spartan Emerging Markets Index (FPEMX): 28%
- (Source: Morningstar as of 6/30/2015)
You may notice that the Dimensional Funds listed here has a significantly lower China allocation than the rest. This difference is because the other 3 funds are all following market-cap-weighted indices. Dimensional determines caps on each countries exposure that may vary from the index. Dimensional uses this approach to control risk and more broadly capture exposure to many different emerging markets economies.
Vanguard has announced that they will begin including China A shares in their Emerging Markets ETF gradually over the next year. The transition is expected to begin in 3rd or 4th quarter this year. After that transition, China including the A-shares is expected to represent about 32%*** of the emerging markets stock fund.
What all these statistics mean
If you’re one of our clients following our advice, unless you’re a very conservative investor with no emerging markets stock in your portfolio, you have some exposure to China. However, most clients have a range between 1% and 8% of their portfolios in emerging markets. If China represents 17% – 28% of the emerging markets funds, then it’s at most about 2% of the portfolio. And today, none of it would include the mainland China stocks.
So, when you hear news about the China stock market collapsing, it is something that matters. It may significantly affect China’s economic development and a whole generation of Chinese investors. But, for today, it has very little effect on your portfolio.
*Source: Morningstar, Shanghai SE Composite PR CNY index daily returns ending August 7, 2015.
** Source: Morningstar, MSCI China NR USD daily returns ending August 7, 2015.
***Source: FTSE data as of 6/30/2015.