Fri. Jul 1st, 2022

According to research by Bank of America, up to a quarter of the revenue generated by the constituent companies of exchange-traded funds focused on US equities came from sales to China.

The analysis shows how difficult it is for investors to avoid the downturn due to the collapse of Beijing in the private sector.

“What’s happening in China does not stay in China,” BofA said, with the correlation between growth in earnings per share in the US S&P 500 and Chinese economic growth from zero in 2010 to 90 percent, highlighting the importance of the US gross domestic value exceeds product growth for US equities listed.

About 30 percent of global GDP growth over the past two decades comes from China, more than 21 percent from the U.S., while nearly 80 percent of the S&P 500’s margin expansion since 1990 has been driven by globalization, the bank added.

BofA found that 79 S&P 500 businesses generate at least 5 percent of their revenue from China, a figure that rises to 63 percent for casino operator Las Vegas Sands and 70 percent for rival Wynn Resorts, both strongly focused on Macau -market.

The next highest were chipmakers Qualcomm, with 60 percent, and Texas Instruments (55 percent), followed by laser developer IPG Photonics (42 percent).

The line chart of iShares MSCI Emerging Markets ex-China ETF (EMXC) versus iShares MSCI China ETF (MCHI), which is being rebuilt and shows that Chinese stocks have fallen in recent months

Worldwide, it identifies 303 listed companies, with a total market capitalization of more than $ 19 tons, generating at least 5 percent of their revenue from China.

Separate analysis by Jared Woodard, head of the research investment committee at BofA, found that 138 of the bank’s 251 ETFs, based on their shareholding in these 303 companies, generate at least 3 percent of their underlying revenue from China.

Apart from funds focused on China, emerging market ETFs were most exposed, with their constituents usually between 25 and 45 percent of their income from the country.

However, it has been found that even some ETFs listed exclusively on equities in the US have high exposures, led by the iShares Semiconductor ETF (SOXX), of which voters generate 27.9 percent of their revenue from China, according to figures from BofA.

The VanEck Semiconductor ETF (SMH) is not far behind, with 25.8 percent, with VanEck Low Carbon Energy ETF (SMOG), which follows a global index of 19.1 percent, and the First Trust Nasdaq 100 Technology Sector Index fund (QTEC), at 16.6 percent.

“Many U.S. businesses have built up a lot of dependence on revenue from China,” Woodard said. ‘Investors may not be aware of it. People know the mandates of the funds they usually buy, but what they may not know is that businesses worldwide have become increasingly dependent on China. ”

The figures may even underestimate the exposure to ETFs to China. Some funds will own companies that earn some revenue from China, but less than the 5 percent threshold used in BofA’s analysis, which means their contribution is missed. In addition, not all businesses disclose the full geographic breakdown of their sales, Woodard said.

The research also only covers revenue from China, not other possible vulnerabilities such as supply chains.

‘Income exposure is something we can measure [but] it is only a reflection of their relationship. [Via] broader trade, labor pools, there are many ways that means economies around the world are more connected than before, ”Woodard added.

His analysis found that some of the ETFs with little exposure to China with comparable China-centric funds have performed better by as much as 37 percentage points since the start of the pandemic in March 2020.

Bar graph of divergent performance of high vs. low-income ETFs in China (percentage points) showing that exposure to China has hurt performance since the low of Covid

The gaps are particularly large for consumers’ discretionary funds, where some ETFs hold China, education and luxury stocks in China, while others do not.

The gaps are also noticeable for funds following an environmental, social and management mantra and those focused on emerging markets.

Although each stock market has its ups and downs, Woodard argued that China’s current combination of long-term concerns about issues such as demographics and potential growth, cyclical headwinds such as tight monetary policy and ‘political interventions in the name of general prosperity’ means ” The risk may outweigh the benefits “.

Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, said the analysis highlights the need for investors to be aware of what is in their funds.

‘The geographical location of a business is somewhat arbitrary. It does not necessarily relate to where it makes money. “Shell and BP are listed in the UK, but that’s not where most of their revenue comes from,” Lamont said.

“American companies have a fairly large domestic footprint because they have a large internal market, but in a globalized world, we all depend to some extent on how well China is doing.”

BofA also noted that since 2017, investment funds have been underweight from an equal weight position in U.S. companies with high exposure to China to more than 10 percentage points.

ETFs, which are predominantly passive, do not have the opportunity to follow suit, although these stocks are trading at a record 25 percent against their peers, according to BofA.

Rahul Sen Sharma, managing partner of Indxx, an index provider, said “only time will tell”, or the decision of active executives to underestimate US stocks heavily exposed to China.

‘We’ll have to see how the returns build up over the long term. Passive investing usually wins more than active, ”he said.

Lamont agreed, saying: “next week something could change and these active drivers will be caught off guard.

“Sometimes [active management] paid, and sometimes not. Maybe it will bear fruit this time, but most active drivers do not make enough calls in time. ”

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