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Fund Family Shareholder Association
www.adviseronline.comCHINA’S A-SHARES?
Small-cap for-
eign stocks? What’s all the fuss?
In June, Vanguard announced chang-
es to benchmarks tracked by four of its
foreign stock index funds (and their
ETF shares). All of the funds will be
adding small-cap stocks to their portfo-
lios, but what’s gotten all the attention
is the addition of Chinese “mainland”
stocks—known as “A-shares”—to
Emerging Markets Stock Index
. For
all the noise this change has generated,
the impact is pretty small.
Great Wall of China Crumbles
While China’s economy is the
world’s second largest, stocks traded
on its mainland exchanges in Shanghai
and Shenzhen (A-shares), unlike those
traded in Hong Kong (the H-shares),
have been excluded from the major
emerging market indexes because for-
eigners were prohibited from buying
them.
But that Great Wall is crumbling.
Vanguard announced that over
the next 12 to 18 months, Emerging
Markets Stock Index would transition
to a FTSE benchmark which includes
Chinese A-shares. Investors have been
anticipating for some time the inclu-
sion of stocks of companies that have
A-shares but not H-shares and hence
have never been in any emerging mar-
ket indexes. But in reviewing these
changes, it’s pretty clear that the impact
on portfolios and performance certainly
doesn’t match the hype, and for most
investors, who only dabble in emerging
markets to begin with, the impact will
be negligible at best.
If the impact on investors will be
marginal, then why all the buzz? I’d
love to say “It’s Chinese to me!” but
there’s more to this story.
Historically, foreign investors have
been unable to hold Chinese A-share
stocks. Period. But recently the Chinese
government has allowed certain foreign
investors to invest a limited, prescribed
amount in A-shares. In essence, they’ve
created quotas for some investors. This
gives the A-shares an air of exclusiv-
ity—people always want what they
can’t have.
Recent Szechwan-like performance
has also made A-share ownership a hot
ticket. The Shanghai market is up more
than 105% over the past 12 months,
while the Shenzhen market is up over
120%. Eye-popping performance and
limited supply is just the recipe for
investor interest.
Yet, for all the attention the
announcement that A-shares are com-
ing to U.S. shores has garnered, the bot-
tom line for investors like you and me is
that this simply adds more noodles and
tofu to our already hot and sour soup,
without improving the taste.
First, if you’ve focused on
Vanguard’s adoption of A-shares into
Emerging Markets Stock Index, the
change won’t happen overnight. The
transition to the new benchmark starts
on an undisclosed date in the second
half of the year, and the fund will follow
a transition index for a year or so before
reaching its final destination. The long
transition time is designed to limit
trading costs and market impact, but
is also a result of the restricted amount
Vanguard can invest in A-shares.
Second, it isn’t as if Emerging
Markets Stock Index is starved for
Chinese shares—it already has near-
ly 30% of assets in Chinese stocks.
Adding the A-shares will introduce
some new stocks to the mix—there
are only 135 or so stocks that are
listed both on the mainland as well as in
Hong Kong, mostly the largest Chinese
companies like Tencent, China Mobile
and China Construction Bank.
And investors aren’t about to get an
oversized helping of A-shares. Why?
The Chinese market is not completely
open—there are those quotas. FTSE
adjusts the weight of the A-share stocks
for the quota limits, so while Vanguard
expects to add some 1,400 Chinese
stocks to the fund, the A-shares will
only account for 5.5% or so of the new
benchmark. (Don’t expect to see any
A-shares in the top-10 holdings of the
fund.) This in turn only increases the
fund’s allocation to China by about
3%, as the current Chinese shares will
get a smaller weight in the benchmark.
It isn’t as if the fund’s complexion is
going through a massive change. (The
quotas are also why A-shares aren’t
being added toVanguard’s other foreign
index funds like
Total International
Stock Index
or
All-World ex U.S.
Index
.)
For all the headlines about A-shares,
the fact is that their impact on perfor-
mance is a lot more bland than spicy.
The performance of the current FTSE
emerging markets index that Vanguard’s
fund tracks now and that of the fund’s
new bogey—which includes small cap
stocks as well as those much-discussed
Chinese A-shares—has been nearly
identical over the past decade or so.
Since the end of 2005 (the earliest
data I could find) through the end of
CHINA STOCKS
Marketing Coup for Vanguard, Meh for Investors
China A-SharesMore
Bark Than Bite
5/06
5/07
5/08
5/09
5/10
5/11
5/12
5/13
5/14
5/15
FTSE Emerging Mkt. Idx. (current benchmark)
FTSE EM Index w/ small-cap stocks and
Chinese A-shares (new benchmark)
$60
$85
$110
$135
$160
$185
$210
$235
$260
The bottom line is that
A-shares simply add more
noodles and tofu to our
already hot and sour
soup, without improving
the taste.