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Affluent Christian Investor | July 10, 2020

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The Case For Underweighting China In An International Portfolio

The Chinese economy is in a bit of a trouble. The trade war and tensions in Hong Kong are certainly contributing to their weaker performance, but it’s been years since China grew at the shocking pace that once defined its economy. GDP growth in China used to be well in excess of 10% a year: now it’s around 6% a year.

Let’s not overstate the problem: 6% is a good growth rate, and almost any developed economy would be happy to have a single year of growth that high. But it does beg the question: How invested in China should you be today?

The index I work on, VIEQX, has a lot invested in China. As of January 31st 2019, out of 39 countries, it was our 14th highest holding, at 2.88%. But ACWX, a cap-weighted index, had China at 6.54%.

As we repeatedly emphasize, cap-weighting is past-weighting. Too often, a cap-weighted approach leads to over-investment in once-great countries and under-investment in soon-to-be-great countries. While China is still clearly a dynamic and quickly growing economy, it’s been unable to maintain the growth rates that brought it to this point. At least in part, the slowdown is caused by a freeze or even reversal in the economic liberalization that has defined the Chinese economy since 1979.

The recent tensions with Hong Kong threaten to exacerbate this problem: China has been doing a very difficult balancing act, pursuing economic liberalization without political liberalization. The protests in Hong Kong may make the Chinese leadership even less interested in transitioning to a free market economy, as that tends to lead to political liberalization as well.

None of this is to say that China is a bad investment, or that an international index shouldn’t have any money in them at all. But it is to say that China isn’t growing as fast as it once was, and in turn might not deserve the weighting it once did.

 

 

Originally published on Townhall Finance.

 

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