Allan Lane, AlgoChain

Lyxor’s emerging markets ETF goes underweight China


Regular columnist Allan Lane of Algo-Chain runs the rule over Lyxor's new emerging markets ex-China ETF…

The issue of what constitutes a good investment strategy in emerging markets equities is a very topical one.  China has just turned in its lowest GDP figure since records began, which at 6.2 per cent would be the envy of many developed market countries, however, in China though, this could well signal a trend lower that is hard to stop. This news may well prompt many managers to reconsider their conviction to investing in that region, not to mention the risks that come with the US-China trade war.

Lyxor's most recent ETF listing on the London Stock Exchange is the first ETF in Europe that offers exposure to Emerging Markets equities with China removed and arrives with perfect timing. Launched with an annual management fee of 0.3 per cent, this fund tracks the 25 countries that comprise the MSCI Emerging Markets Ex-China Index. This reduced index sees the top 3 constituents comprise South Korea, Taiwan and India with weights of 18 per cent, 16 per cent and 13 per cent respectively, and is replicated using a swap-based structure.

Precisely how many ETFs one should include when building a multi-asset global portfolio is open to question, but if you already have invested in an equity ETF that tracks MSCI's Emerging Markets Index, then this new ETF allows you to add your own personal touch. With this newfound freedom, you can both change the size and choice of your allocation to China.

Maybe I am making the problem harder than it really is, but in many ways the challenge of using ETFs to map out the patchwork quilt of our in-house asset allocation model reminds me of the four colour theorem.  When colouring adjacent countries on a map, it turns out that one only needs four different colours to complete the task in hand. However, in a world where ETF providers don't launch funds to suit my needs, what's the least number of ETFs that I need to capture the equity exposure that I was aiming for without double counting?
 
Nothing better illustrates the view that investment management is part science and part poetry. Exactly how should one determine which investments to make into China equities, active or passive selection? The problem is that even if one chooses to allocate via an index tracker, which index tracker did you have in mind? 

At Algo-Chain our view is that this is a tough call and prefer to rely on an empirical evidence-based framework based on the past behaviour of those benchmark indices across as many economic cycles as we can lay our hands on. Currently, based on the data we collect from the OECD organisation, our forecasting models favour (in descending order) iShares China Large Cap UCITS ETF, Xtrackers Harvest FTSE China A-H 50 INDEX UCITS ETF and Lyxor China Enterprise (HSCEI) UCITS ETF. In all cases the trading signals are slightly weaker than for the previous month.

There lies the beauty of this ETF from Lyxor.  Designing one's allocation along the lines of EM Equities ex China plus a separate allocation to China itself has its merits. No two investor’s views are the same, and nothing beats the option of giving the investor the choice to do their own thing.

For many years one could invest in Asia ex Japan, so the idea of splitting out the largest member of an index is hardly new.  What it does show though is that Lyxor's product development team is addressing the issues that matter to the investor community and is not just focused on the latest fad. That is no bad thing.

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