China and ESG ETF closures soar in face of political backlash

More US-listed China-focused exchange traded funds have closed down since the start of this year than in any previous full year as investors continue to fight shy of the world’s second-largest economy.

Liquidations of ETFs investing on the basis of environmental, social and governance (ESG) factors are also on track to smash through prior records — both in the US and globally — amid a backlash against the concept.

The culls have been enacted despite ever rising enthusiasm for ETFs globally, with 58 successive months of net inflows taking assets to a record $12.7tn at the end of March, according to ETFGI, a consultancy.

In the first quarter of 2024 alone 13 US-listed China ETFs shut their doors, far in excess of the previous full-year record tally of five in both 2020 and 2023, according to data from Morningstar Direct.

Globally, 18 China ETFs closed in the quarter, more than half of last year’s record total of 34, with Global X, Xtrackers and KraneShares among the axe wielders.

The first quarter also saw the demise of 30 ESG ETFs globally, according to Morningstar, on course to exceed the annual record of 72 in 2023. Xtrackers, Lyxor and WisdomTree were among the groups to prune their range.

“Both have become political footballs,” said Bryan Armour, director of passive strategies research, North America at Morningstar.

He said the House of Representatives select committee on the Chinese Communist party had even gone so far as to single out BlackRock and MSCI accusing them of fuelling China’s military advancement or facilitating the CCP’s human rights abuses, “when BlackRock and MSCI simply offered cap-weighted emerging markets and China ETFs”.

The rate of launches has also slowed sharply for both investment theses. Just 33 China ETFs were unveiled in Q1 — all but three of them domiciled in either China or Taiwan. This compares with 160 during calendar year 2023 and a record 291 during the peak of the enthusiasm in 2021.          

The 18 ESG launches in the first quarter are an even sharper slowdown from last year’s 151 and 2021’s zenith of 313, the Morningstar data show. Just three of these launches were in the US, well below the pace of 38 launches last year and a high of 75 in 2021. 

In the US at least, the volume of assets held in the remaining ETFs in both categories has also fallen. US-listed ESG ETFs held $102bn at the end of March, down from $117bn at the end of 2021. China ETFs listed in the US had just $24.2bn, below the $35.6bn of December 2021.

In both cases global ETF assets have risen, despite the rash of closures. Worldwide, ESG ETFs now have a record $542bn of assets, propelled by rising demand in Europe.

Similarly, China-focused ETFs now hold $364bn, up from $320bn at the start of the year. In this case, growth appears to largely have been driven by China’s “national team” of state-backed institutions, which ploughed Rmb410bn ($57bn) into domestic equity ETFs in the first two months of 2024 alone, according to calculations by UBS.

In the US and Europe combined, assets held in China ETFs fell to $34.8bn at the end of March, 26 per cent below the peak of $47.2bn at the end of 2021, when many judged that China had been more successful than the West in navigating the Covid pandemic.

So far no ETFs have been launched outside China to track the country’s CSI A50 index, launched in January and designed to pump money into sectors deemed strategically important by Beijing, such as renewables and semiconductor manufacturing. There are 10 domestic Chinese CSI A50 ETFs.

Both global geopolitics and domestic pressures, particularly in the US, have been factors behind the declining popularity of both concepts.

“ESG has become a political lightning rod,” said Todd Rosenbluth, head of research at VettaFi, a consultancy. “Many asset managers are less eager to offer a broad suite of products as they were in the past. It is less likely that the style returns to be a hot area in the near term.”

An additional factor behind the waning interest is poor performance. Mainland China’s CSI 300 index has fallen 9.9 per cent over the past year, and 26.8 per cent over three years. In comparison, the FTSE All-World index has risen 18.2 and 10.3 per cent over the same time periods, while America’s S&P 500 has gained 25.5 per cent and 22.7 per cent respectively.

ESG has also underperformed, although not as badly — perhaps unsurprisingly as funds hold many of the same stocks as non-ESG vehicles.

The iShares MSCI USA ESG Select ETF (SUSA), one of the largest such vehicles, returned 19.9 per cent in the year to April 30 and 18.1 per cent over three years, a little below the 23 per cent and 22.3 per cent returned over those respective periods by the non-ESG iShares MSCI USA Ucits ETF (CSUS), which shares many of the same the largest holdings.

This does, at least, suggest investor interest could be rekindled if Chinese and ESG stocks regain their mojo.

Armour said “narratives can shift quickly once profits are at stake”. But he cautioned that not all investors will be happy to change tack.

“Some investors will flock to China or ESG ETFs once performance turns around, but those strategies seem to be off the table for the ideologically entrenched,” he added.

“I think the lack of interest in China-focused ETFs has been more performance-driven, whereas the waning interest in ESG ETFs is more politically oriented,” said Nate Geraci, president of financial adviser The ETF Store.

“As a result, I think it’s much more likely money comes pouring back into China-focused ETFs than ESG ETFs — if and when performance turns. ESG has become way too politicised and I’m not sure how it can overcome that moving forward.”