Investors in emerging-markets stock funds are getting hit with a one-two punch. Just weeks after the Russian invasion of Ukraine led to the collapse of that country's stock market, Chinese equities resumed their own slide, leaving many emerging-markets funds down 20% in just the past month.
Prior to a big rally on Wednesday, the recent steep declines in many Chinese stocks came on top of losses in that market going back to last Summer.
"The biggest risks in emerging markets are what I broadly include under the umbrella of political risks," says senior Morningstar analyst Daniel Sotiroff. “At the moment, these types of risk are showing up in a big way.”
The average emerging-markets fund has lost 13.4% in the past month. That includes a 12.9% loss on the largest fund in the emerging-markets Morningstar Category, the $71.7 billion Vanguard Emerging Markets Stock Index VEIEX, and a 20.6% loss on the $33 billion Invesco Developing Markets ODVCX, the fourth-largest of the group.
Behind these losses is that fact that most emerging-markets stock funds have heavy weightings in Chinese stocks. The average stake is 25%, 5 times the exposure that the typical fund had to Russia a month ago. With trading in Russian stocks halted, many emerging-markets funds have written the value of those holding off as a total loss.
That’s been bad news for investors, as Chinese stocks have sold off sharply in recently days amid a growing dispute between Chinese and U.S. regulators that threatens some of the country's best-known companies with delisting from U.S. exchanges. Compounding matters, the omicron coronavirus variant is now hitting Hong Kong and China hard, leading to lockdowns in some of China's biggest industrial cities.
Over the past month, the S&P/BNY Mellon China Select ADR Index, which tracks Chinese companies trading on U.S. exchanges, has fallen 36% through March 14. The Hang Seng China Enterprises Index, which tracks Chinese companies trading on the stock exchange of Hong Kong, lost 24% in the same time frame, reaching levels last seen six years ago. In the past month, Alibaba BABA is down 36% and Tencent TCEHY has lost 32%.
Broad-Based, Big Declines in China Stocks
The decline in Chinese stocks been broad-based, with every sector posting negative returns over the past month. By far, consumer cyclical stocks have fallen hardest.
Usually economic trends drive the performance of cyclical stocks, but lately, regulatory worries have played a major role as well after Chinese regulators cracked down on internet stocks such as Alibaba and Tencent last year.
Among other stocks fueling the broad China market losses, food delivery services provider Meituan MPNGF lost 38% in the past month. Separately, the Securities and Exchange Commission warned that five Chinese companies--including Yum Brands YUM and ACM Research ACMR--could be delisted from U.S. exchanges in 2024 if they fail to meet certain accounting and disclosure standards.
While China’s economy has grown substantially in recent decades, as a stock investment, any gains have evaporated recently. Over the past decade, the Hang Seng Index is down 16% and the S&P/BNY ADR Index is down 15%. More broadly, the Morningstar Emerging Markets Index has fared better, returning 42% for the past 10 years. But that performance pales in comparison to the U.S. stock market, where the Morningstar U.S. Market Index has returned 254%.
All this matters in a big way to emerging-markets stock fund investors. The indexes against which mutual funds benchmark their portfolio holdings and performance have seen a higher levels of China exposure over the years. For example, the Morningstar Emerging Markets Index has a 30% weight in China, up from 16% 10 years ago and 11% 15 years ago. Today's weight for China is well above the second-largest country weight. Taiwan clocks in at roughly 16%, and India is third at 14.5%
“China’s immense weight hurts diversification in a lot of emerging-markets funds,” says Sotiroff.
Which Funds Hold the Most China Stocks?
Global X Emerging Markets Internet & E-commerce ETF EWEB focuses on the two hardest-hit groups of stocks: communication services companies and e-commerce firms. Overall, 72.9% of the fund was invested in Chinese companies as of Dec. 31, 2021. The fund has lost 36.2% in the past month, the most of any fund in the category. The largest technology-focused emerging-markets fund, the $588.8 billion Emerging Markets Internet & Ecommerce ETF EMQQ has lost 32%, and KraneShares Emerging Markets Consumer Tech ETF KEMQ posted similar losses.
Columbia Emerging Markets Consumer ETF ECON, down 20% in the past month, has heavy exposure to China thanks to its focus on the consumer discretionary, consumer staples, and communication services sectors.
New pandemic restrictions in China hit Qualcomm QCOM (down 7.25%) and Trip.com ADR TCOM--the top holdings of AMG GW&K Emerging Wealth Equity TYWVX. The fund also carried a 4.3% stake in Yum China YUMC as of Feb. 28, 2021, one of the five companies the SEC is targeting with the threat of delisting. Almost half of the fund’s portfolio is in Chinese companies; the fund has lost 21.5% in the past month.
The Worst-Performing Emerging-Markets Funds
Emerging-markets funds with larger stakes in Russia and China have taken the largest hits this year, particularly Invesco Emerging Markets Innovators EMVCX and iShares Emerging Markets Dividend ETF DVYE.
Morningstar analyst William Rocco notes that Artisan Developing World ARTYX manager Lewis Kaufman “regularly allows his stock selection to lead to sizable country and sector overweightings.” Rocco notes that “some of the aggressive aspects of the process have backfired in the past year, and this strategy has posted inferior returns. But Kaufman has usually executed his distinctive discipline with skill.”
While Harding Loevner Emerging Markets Portfolio HLMEX had a lower stake in Chinese stocks, the fund had above-average exposure to Russia that hurt performance.
For Invesco EQV Emerging Markets All Cap GTDCX, Morningstar analyst Gregg Wolper wrote that the fund's “willingness to deviate from indexes and peers can lead it astray at times, but for the most part, the fund's approach and its topnotch team give it a good chance to succeed.”
Funds That Escaped the Emerging-Markets Dive
Funds that don’t invest in Chinese technology companies--often meaning funds focused on small-cap or value-oriented companies--which are harder to come by in China--have held up the best. Freedom 100 Emerging Markets ETF FRDM, which invests only in countries with high degrees of personal and economic freedom, has avoided the meltdowns in both the Chinese and Russian markets.
Funds that track low-volatility indexes also felt less of an impact from the Chinese stock selloff. Invesco S&P Emerging Markets Low Volatility ETF EELV has lost only 2.4% the past month, 10 percentage points better than the average emerging-markets funds. Similarly, despite a 23.6% weight in Chinese companies, Fidelity SAI Emerging Markets Low Volatility Index FGKPX is down only 5.9%.
The silver lining for most fund investors is that emerging-markets funds are typically a small portion of a well-diversified portfolio. “While it’s a big part of many emerging-markets funds, China represents less than 4% of the global stock market, so it’s likely less of a concern to investors that are globally diversified,” says Sotiroff.