Comfort with China exceeds $1 trillion

At the turn of the century, investing in China was viewed as a risky proposition. Foreign access to a notoriously volatile, retail-driven equity market was heavily restricted. The lack of a credible regulatory framework and legal protections deterred US venture capitalists from making direct investments in Chinese companies. In many cases, Chinese banks and the country’s fledgling private equity industry also balked. So, when Chinese technology firm Alibaba received its first $25 million investment from Goldman Sachs in 1999, investors sat up and took notice.

Over the next 20 years, the surprise at Goldman Sachs’ boldness has been replaced with a hunger for, and comfort with, exposure to Chinese assets. EPFR has seen dramatic growth in both the total mutual fund and ETF allocation to China and the number of dedicated China Equity Funds.

The estimated allocation of EPFR-tracked mutual funds and ETFs to Chinese equities surpassed $1 trillion in 2019 before the Covid-19 pandemic hit in 1Q20. Meanwhile, the number of funds that have a mandate to invest in China has grown significantly.

Chart representing 'Number of China Mandated Equity Funds'

This increase in the number of funds coincided with the rise in various investment styles and sectors. Since 2005, the number of styles and sectors available to investors seeking China exposure has tripled. Beyond the large-cap stock funds that were their first option, investors now have the option to invest specifically in sectors like technology, healthcare, energy, real estate or finance with different sizes and mandates.

Chart representing 'China Equity Funds Style Sector Breakdown'


Breaking free of the emerging markets pack

Fifteen years after its first injection of foreign capital, a heavily oversubscribed IPO in 2014 crowned Alibaba’s success story. Interestingly, this IPO was not made through a domestic exchange: the regulatory and legal frameworks were still more favorable.

With other Chinese companies following a similar path, a wide variety of share class types emerged for Chinese corporates. Mutual funds investing in China have utilized these different share class types to mitigate risk and get exposure to companies that might otherwise be inaccessible.

Chart representing 'EM Funds China Shareclass Allocations'

The growing range of share classes, investment styles and dedicated sector funds for China has been a positive development for asset allocators. It is a development they have taken advantage of. But the sheer volume of these inflows has changed some of the historical relationships between China and the rest of the emerging markets universe.

In the case of the fund flows tracked by EPFR, the flows to dedicated China Equity Funds became noticeably less correlated with the rest of EM – and the US – from 2013 onward.

Chart representing 'EM vs China Mandated Equity Funds, Flows Correlation'

Chart representing 'US vs China Mandated Equity Funds, Flows Correlation'

There has also been a shift in the investment narrative towards China during the last two decades. That narrative has evolved to the point where it is now like the one surrounding global equity. Indeed, Chinese equities and funds have been a good source of diversification within limits.

This narrative held through the initial stages of the Covid-19 pandemic. But, as the rest of the world re-opened, returns for Chinese markets decoupled further from the rest of the world. The average return correlation between China and the rest of the EM is now close to zero.

Chart representing 'US vs China Mandated Equity Funds, Return Correlation'

Chart representing 'EM vs China Mandated Equity Funds, Return Correlation'

This puts China in a different place as an asset class.


Time for new buckets?

A classical multi-asset portfolio optimization relies on covariance matrices and works on long-term correlation assumptions. So, if this significant correlation breakdown with other emerging markets persists, Chinese equities might be considered an independent source of return and risk for most asset allocators.

In portfolio theory, this development is regarded as a good thing that might lead to greater inflows from asset allocators. On the other hand, however, the underlying reasons for this decoupling might have the potential to withhold discretionary investors from investing in Chinese equities.

One solution, already adopted by Global Fund managers in recognition of the US’s outsized footprint in world equity markets, is to divide the global part of emerging markets fund universe into Global Emerging Markets (GEM) Equity Funds and GEM ex-China.

This may be an idea whose time has come.


Did you find this useful? Get our EPFR Insights delivered to your inbox.

Related Posts

Off the wires: Bitcoin is one year away from a major technical event. History suggests the start of another bull run

Off the wires: Bitcoin is one year away from a major technical event. History suggests the start of another bull run

Bitcoin’s next “halving” is expected to take place in 2024. These events take place when Bitcoin miners have added 210,000 “blocks” to the blockchain leger and are marked by a halving of the Bitcoins that miners get for adding each block. Given the implications for future supplies of Bitcoin, these ‘halvings’ usually push Bitcoin’s price significantly higher, both in the run up to the event and for several months afterwards. This time around seems – so far – to be conforming to the pattern: Bitcoin’s price has risen steadily in recent weeks.

Off the wires: US inflation falls to lowest level since May 2021

Off the wires: US inflation falls to lowest level since May 2021

According to CNN, annual inflation dropped in March 2023 for the ninth consecutive month, and grocery prices fell month-on-month for the first time since September 2020. While the CPI has cooled off – at least temporarily – investors are not treating the news as a green light for the road back to riskier asset classes. With fear far from banished, cash remains king.

When ETF flows confound expectations

When ETF flows confound expectations

From time to time, EPFR’s clients alert us to anomalous flows into exchange traded funds (ETFs) that occur on a specific day and for a specific fund. Given our awareness of these types of flows, and the granularity of our databases, EPFR’s quant team decided it was high time they dove into our ETF database and conducted a systematic analysis of these events.

Better, More Actionable Insights

Let us show you how EPFR can create value for your specific strategy


*Indicates required fields

By ticking this box, you agree to receive marketing communications from EPFR. You can review your email preferences upon submitting this form