Western investors flock to China equity ETFs

Western investors pumped a record amount into Chinese equity exchange traded funds in June as the mainland stock market surged ahead of its major rivals.

The flood of cash into the Shanghai and Shenzhen bourses came as the country’s draconian Covid lockdowns were eased and regulators telegraphed a less severe approach to policing China’s tech sector almost a year after kicking off an unprecedented crackdown.

Both US and European investors poured record sums into the Chinese market, with US-listed ETFs taking in a net $4bn and those domiciled in the Europe, Middle East and Africa region sucking in $1.8bn, according to data from BlackRock. The combined total of $5.8bn comfortably exceeds the previous record of $4.3bn set in January.

The European buying spree occurred even as Emea investors pulled money from both US equity ($900mn) and European equity ($800mn) ETFs.

“European investors are not really buying US equities, not really buying Europe, but they are buying China. That’s a marked change in global flows,” said Natasha Sarkaria, investment strategist at BlackRock.

Phillip Wool, head of investment solutions at Rayliant, an emerging market-focused asset manager, said two things had changed in China.

First, a view that Chinese technology companies had become “oversold” coincided with “a lot of signalling that the regulatory crackdown that started a year-and-a-half ago has reached its peak and Chinese regulators want to become more collaborative with these tech companies”.

Second, Wool said China’s growth outlook had “soured” in recent months amid the Covid lockdowns, leaving the country struggling to meet Beijing’s “lofty” growth targets in the run-up to November’s Communist party congress, when President Xi Jinping is expected to secure a third term.

So, “when the Covid lockdown eased in May it allowed China to pump stimulus into the economy” in the shape of interest rate cuts, fiscal stimulus and higher infrastructure spending, he said.

As a result, China’s stock markets outshone rival bourses in June, with the CSI 300 index returning 9.6 per cent even as virtually every other stock market fell amid gathering fears of stagflation. Only Russia’s RTS Index, with a gain of 11.3 per cent but out of reach to western investors, performed better, and that has since given up all its gains.

Karim Chedid, head of investment strategy for BlackRock’s iShares arm in Emea, believed it was this outperformance that sucked western investors back into China, but warned it might not last.

“We will probably see some stop-start activity around Covid lockdowns in the second half,” he said, as Beijing continues to implement a harsh zero Covid strategy.

In contrast, with US equities looking “terrible” as the Federal Reserve “looks pretty locked in to a series of rate hikes”, Wool believed the Chinese stock rally could continue “for most of this year, and maybe beyond” as investors seek diversification.

Sentiment darkened towards global corporate bonds, though, with investors rushing for the exits amid a worsening economic backdrop.

Outflows from investment grade bond ETFs hit $4.5bn in June, the worst figure on record barring the Covid-induced market meltdown of March 2020. High-yield bond funds shipped $5.5bn, the third worst-ever monthly tally.

Although flows into investment grade funds remain positive year-to-date, this is shaping up to be a nadir for high-yield: a net $18.3bn has exited the sector’s ETFs so far this year, dwarfing the all-time full-year record of $10.7bn, set in 2018.

The sell-off has gone so far that European high-yield spreads are now pricing in a European recession, said Chedid.

Overall fixed income ETF flows slumped from $35.3bn in May to just $3bn in June. They were kept positive by an ongoing appetite for “haven” US Treasury ETFs.

While flows to this sector slowed from a record $26.1bn in May to $16bn in June, US Treasury ETFs still accounted for 44.2 per cent of all ETF buying last month, despite only constituting 3.1 per cent of the global ETF industry’s $8.7tn stock of assets.

The picture was worst in Europe, where investors withdrew a net $2.3bn from fixed income ETFs of all stripes in June, and $1.6bn from commodity funds.

“Investors are positioning for the building fears of a global recession,” said Scott Chronert, global head of ETF research at Citi. “Fixed income flows show a clear flight to safety as ETF investors remain macro focused.”