Vanguard has recently submitted plans to launch a new version of its Emerging Markets Stock Index, specifically Vanguard Emerging Markets Stock Index, which will not include China. This isn’t an entirely new strategy for the company; they’ve previously offered options like Vanguard Extended Market Index, which includes all U.S. stocks but the S&P 500, since 1987. They also introduced funds like the global EX-US fund in 2007 and the global EX-US Small-CAP fund in 2009.
What’s a bit different about this filing is that Vanguard doesn’t currently have a dedicated fund solely for China. This means, as investors, you have an either/or choice. You can invest in the traditional Vanguard Emerging Markets Stock Index, which includes China, or go for the new ex-China option.
Curious about how these “ex-” funds have performed historically, I took some time to gather data on funds designed to exclude specific countries while focusing on diversified equity strategies rather than thematic options. I narrowed it down to three categories: Original Japan, Original China, and Original U.S.
For this analysis, I’ll concentrate on the former Japan and China strategies. There are 31 of these (discounting multiple stock classes), with only four being from former China strategies. Since 1999, 18 funds focused on Japan have existed, with 14 either consolidated or liquidated. In contrast, all launched former China funds are still active, likely because they were created in more recent years.
Most existing funds are regionally focused, such as “Asian ex-Japan,” and commonly exclude China by covering a broader range of developing markets. Given that Japan and China often have significant weight in these indices, their exclusion can lead to substantial performance variations.
For example, a comparison of returns over the last decade shows how Japan’s Asia Ex-Japan Index fared against the overall Asian Index that includes Japan. A positive excess return indicates the former index outperformed the latter, while a negative return suggests the opposite.
Another comparison looks at the performance of the original China emerging market index relative to standard indices that include Chinese stocks.
Timing Matters
The timing surrounding the launch of these “EX” funds can greatly influence their performance. I collected data on how many such funds were introduced each year and aligned that with annual return differences for the respective indices over the next decade.
For instance, in 2007, when three Asian yuan Japanese funds were launched, the Asia Ex-Japan index outperformed the standard index by around 1% annually over the next decade, up to December 31, 2017.
While earlier launches of Asian funds tied to the former Japan strategy performed well amidst a rising bubble in the Japanese stock market, later launches didn’t fare as successfully. The outcome highlighted how critical the timing of these introductions can be.
We’re seeing a somewhat similar situation with new funds excluding China, though historical evidence is limited because many of these funds are still quite new. As it stands, only two of these funds have been around for over a decade; others are fairly recent.
Looking at the recent performance, funds that exclude China have performed relatively well so far. However, it’s still a bit early to determine the long-term success of these strategies, especially given that over two-thirds of these funds have launched in the past three years.
Investors should keep a careful eye on this trend; the growing number of newly launched funds excluding China coincides with a decrease in China-only equity funds. Between 2009 and 2018, 42 new China Equity Funds were launched, but since then, only 16 have followed suit. Why this downturn? Chinese stocks have been underperforming.
This is clearly illustrated in the data, which charts overall new China-only fund launches against those excluding China, alongside returns of Chinese stocks relative to other emerging markets. Although the launches of the ex-China funds have been net positive, they appear in the red, reflecting how poorer performance in Chinese stocks influenced the market.
In conclusion, fund companies have historically launched China-only strategies when Chinese equities were thriving compared to other emerging markets. However, as performance waned, we’ve seen a shift toward launching more ex-China funds.
Conclusion
Predicting the future for Vanguard’s ex-China ETF is tricky since many counterparts have not been in play long enough. It’s possible Vanguard might have preferred launching this fund a decade ago when Chinese stocks were performing well, but the current landscape has shifted.
Moreover, while some previous country-focused funds have struggled, the initial reception of ex-China strategies appears promising but remains in early days. Vanguard usually remains committed to its products unless there’s a significant reason not to, so it’s likely the ex-China ETFs could endure longer than expected.
Nonetheless, investors should be cautious. When fund companies decide to go “EX,” it could indicate a major shift in strategy.
It’s Turned On
Here’s what’s currently on my radar:
- Amy Arnott discusses the past year for non-dollar currency holders and the potential for hedging against the dollar.
- Christine Benz and Margaret Giles explore how to ensure adequate retirement income.
- Jason Zvigout examines the pros and cons of secondary funds.
- Tyler Cowen explores which sectors might be affected by advances in artificial intelligence.
- Patrick O’Shaughnessy interviews Spotify’s head of product, discussing future plans and priorities.
- An insightful chat with Jean Spinitsky and Lee Eisenberg regarding upcoming episodes of their show.
- Michael Kiwanuka’s “Lowdown” is worth a listen.
Don’t Be a Stranger
I’m always eager to gather your thoughts or feedback on this article. Feel free to reach out via email with any opinions! If you’d like, you can also find me on Twitter.
