Knowing How Much China Is In Your ETF

The reaction could easily be what else is new or it is just another day at the office as U.S. market participants awoke to news of another big decline in China.

To this point in Tuesday's session, the six worst-performing exchange traded funds in terms of percentage losses are all China funds, reminding investors in diversified emerging markets funds that knowing exactly how much China exposure such a fund features is crucial information.

There are over 260 ETFs that feature some exposure to Chinese stocks. Of course that number includes the most familiar diversified emerging markets ETFs, such as the Vanguard FTSE Emerging Markets ETF (NYSE:VWO) and the iShares MSCI Emerging Markets ETF (NYSE:EEM). VWO and EEM are the two largest emerging markets ETFs by assets.

China is VWO's largest country weight at 27.1 percent, well above the 13.9 percent the ETF devoted to Taiwan at the end of July, according to Vanguard data. EEM's China weight is 24.3 percent, or more than 1,000 basis points larger than South Korea, the fund's second-largest country weight.

Since iShares and Vanguard track indices from different providers, their exposure is tied to what that provider considers a developed or an emerging market. Since 2009, FTSE has classified South Korea as a developed market, based in part of the countrys relatively strong economic position. Meanwhile, in 2014 MSCI removed South Korea from its list of countries under review for reclassification to a developed market from an emerging market, said S&P Capital IQ in a recent note.

IEMG

The iShares Core MSCI Emerging Markets ETF (NYSE:IEMG), which debuted three years ago as part of the iShares core lineup aimed at cost-conscious investors, also sports a significant weight to Chinese stocks. IEMG, which charges 0.18 percent per and has $7 billion in assets under management, has a China allocation of 23 percent, more than 800 basis points in excess of its South Korea weight.

Something else to consider is exactly what Chinese stocks are held by these ETFs. For example, VWO's index provider, FTSE Russell, recently said it will allow China A-shares into its international benchmarks. MSCI, the index provider for EEM and IEMG, is still considering elevating A-shares to its well-known international benchmarks.

In June, Vanguard announced that it will soon begin transitioning to a new FTSE index that will ultimately scale up to a 5.6% weighing in China A-shares that would be separate from the existing 28% stake in China H shares. China-A tend to be issued more by local companies and the shares are only available to qualified foreign investors through regulated systems. In late 2014, China began providing additional yet limited access to this market though there are quotas and regulatory approval for asset managers. As of mid-August, Vanguard has not announced when it would begin gradually adding in A-shares, said S&P Capital IQ.

A-shares are the stocks trading on China's mainland and where primary drivers of the equity market rally there earlier this year. Mainland Chinese equities have also been significant drivers of recent downside in Chinese shares. The six China ETFs with the worst percentage losses on Tuesday are all A-shares funds.