Why Emerging Markets ETFs Are Shying Away From China

China’s not invited to the ETF party.

Last month, Vanguard launched its Emerging Markets ex-China ETF (VEXC), which has exposure to emerging markets equities — except ones classified as being based in China. The fund, which tracks the FTSE Emerging Markets ex-China index, is the latest example of emerging markets strategies leaving out the world’s second-largest economy. The idea is to avoid potential tariff-caused market swings, and other pitfalls, while taking advantage of growing investor interest in ex-China options.

“I get why there’s demand,” said Jeff DeMaso, editor of The Independent Vanguard Adviser. “I don’t think it’s unreasonable for an investor to say, ‘I like emerging markets. I like participating in the economic growth that those countries have. But I’m leery of China.’”

Xi’s All That?

Ex-China ETFs make up a relatively small proportion of all emerging markets funds; there were 14 of them as of October, and 10 have launched since the beginning of 2023 alone, according to Morningstar data. Others have existed for longer, like the iShares Emerging Markets ex-China ETF (EMXC) that launched back in 2017. Other ex-China funds include:

• Dimensional’s Emerging Markets ex China Core Equity ETF (DEXC), which launched late last year and is up 23% year to date.
• The Polen Capital Emerging Markets ex-China Growth ETF (PCEM), which also launched last year and is up 8% year to date.

Investors have been shying away from China in part because of the current administration’s ongoing trade war, as well as state-owned companies making up a large percentage of its market. The country also has issues with transparency and investor protection. “If you step back [and ask], ‘What are some of the fundamentals of strong long-term returns?’” DeMaso said. “You could argue [for a] free market, clear and consistent rule of law … There’s a long-term case here that China doesn’t check some of those boxes.”

Bull in a China Shop. Just because an economy is quickly growing, however, doesn’t mean it will outperform its slow and steady counterparts. Vanguard’s Developed Markets Index has roughly doubled the return of the Emerging Markets Index since 2009. As for emerging markets funds that include China, the iShares Core MSCI Emerging Markets ETF (MSCI) is “by orders of magnitude” the largest, said Morningstar passive strategies analyst Zachary Evens. China occupies more than a quarter of that fund’s holdings, Evens added. Whether to include China, then, becomes a matter of individual investor preference, according to DeMaso. 

“I think if you’re an investor, it’s like, ‘Do I just want to index as broadly as possible?’ You should probably include some China in that,” he said. “I also think it’s reasonable for someone to say, ‘I would rather avoid that type of environment.’”