328: Are You Underweight Chinese Stocks? Pros and Cons of Investing in China

Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode, 328. It’s titled “Are you underweight Chinese stocks? Should you be?”

I recently got an email from a member of Money For the Rest of Us Plus. He lives in Switzerland but grew up in Asia. He mentioned that he has been a long-term investor in China, and as he analyzed his Chinese equity investments in 2020, he noticed that they didn’t fall as much as stocks in other countries, and the currency held its value relative to the U.S. dollar.

He went to look at his overall exposure to China. He was trying to calibrate it within his portfolio. He noticed that relative to the size of the Chinese economy, which is the second-largest in the world, that he was underweight Chinese stocks. In fact, the major stock indices, MSCI All Country World Index has 5.2% in China, yet China’s gross domestic product, the monetary value of their output is over 16% of global GDP. He was trying to figure out what should his weight be. He’s primarily getting his performance through an A-share ETF. China’s A-shares are stock shares that trade on mainland China, and they trade in the local Chinese currency, the Yuan. They trade on the Shanghai Stock Exchange, and the Shenzhen Stock Exchange.

China A-Shares

Historically, these Chinese A-shares were only available to domestic investors, but since 2003, China has allowed certain institutional investors to acquire licenses to be able to purchase some of these Chinese A-share stocks. For example, back in 2015 Vanguard was first allowed to buy these Chinese A-share stocks up to 1.5 billion dollars. It was at that time they added Chinese A-shares to their emerging market stocks index fund and ETF.

Trading in A-shares has typically been dominated by local Chinese investors, and returns have been volatile. In 2020 though, they gained 41%. Incredible performance. It was the result of the Chinese economy performing better than any developed or developing economy in the world in 2020.

In this episode, we’re going to look at “What should our weight be in China in our stock portfolio?” There’s definitely some pros and cons to investing in China, and that’s what this member was trying to figure out—what should his weight be in China? 

China’s Economic Growth

In 2020, the Chinese economy officially grew 2.3%. Some of its weakest annual rate of growth, but the best in the world.

Now, there’s always some controversy regarding how accurate are the official economic statistics in China. I subscribe to Capital Economics, which produces something called the China Activity Proxy, and it’s an estimate of economic growth using different metrics that they have much more confidence in. They show that the economy grew close to 7% in the fourth quarter, up from 4.9% in the third quarter. This is on an annualized basis.

Chinese GDP—its gross domestic product, the measure of what it produces, its output of goods and services, has been growing faster than many areas around the world for over a decade. As a result, the Chinese economy is getting to be a larger percentage of overall global GDP.

In China—and this is data from Moody’s, referenced in an article on The Wall Street Journal, China in 2010 made up 10% of world GDP. The U.S. in 2010 was 23.2% of global GDP. At the end of 2020, China had grown to 16.8% of global GDP, while the U.S. has shrunk to 22.2%. So China added 6%, the U.S. lost 1%. 

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