(PUB) Investing 2015

CHINA STOCKS Marketing Coup for Vanguard, Meh for Investors

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 The bottom line is that A-shares simply add more noodles and tofu to our already hot and sour soup, without improving the taste. 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’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

China A-SharesMore Bark Than Bite

$110 $135 $160 $185 $210 $235 $260

FTSE Emerging Mkt. Idx. (current benchmark) FTSE EM Index w/ small-cap stocks and Chinese A-shares (new benchmark)

$60 $85

5/06

5/07

5/08

5/09

5/10

5/11

5/12

5/13

5/14

5/15

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.

12 • Fund Family Shareholder Association

www.adviseronline.com