Trader Talk: As trade war rages, it's suddenly controversial to own Chinese stocks

Key Points
  • Lawmakers ask the Federal Retirement Thrift Investment Board to reconsider the index it uses to keep federal workers from owning China stocks.
  • MSCI, one of the largest index providers in the world, rebalanced most of its global indices.
  • State-owned enterprises are a common feature in the emerging market investment world.

The controversy over China trade is spilling over into a formerly quiet area of the stock market — the business of investing in the global markets.

Volume at the NYSE saw a modest spike going into the close because MSCI, one of the largest index providers in the world, rebalanced most of its global indices.

That rebalancing included the MSCI Emerging Market Index, an index that represents emerging market countries including South Korea, Taiwan, Mexico, Brazil, India — and China. It is used as a benchmark for many funds and ETFs, including the iShares Emerging Markets ETF (EEM).

MSCI is increasing the weighting of mainland China shares in this and other indexes, so that mainland China will have a slightly higher weighting in the index (2.46%) than before, and will again be increased in November, to 3.3%.

This is part of a multiyear process to increase the weighting of mainland China stocks in the global stock indices.

The reason: Mainland China's stock market has been growing and is underrepresented in global indexes. Investors have been increasingly demanding wider access to global markets, and global index providers like MSCI have been slowly increasing China's weighting.

The company was unavailable for comment at the time of publication.

None of this was controversial, until the trade wars. This week Sen. Marco Rubio and a Senate Democrat, Jeanne Shaheen, sent a letter to the chairman of the Federal Retirement Thrift Investment Board asking the group to reverse a decision to use the MSCI All Country World ex-U.S Index as the basis for a public pension fund held by federal staffers.

They are objecting to federal workers owning China stocks.

"The FRTIB's decision to track this MSCI index constitutes a decision to invest in China-based companies, including many firms that are involved in the Chinese Government's military, espionage, human rights abuses, and 'Made in China 2025' industrial policy, and therefore poses fundamental questions about the board's statutory and fiduciary responsibilities to American public servants who invest in federal retirement plans," the letter stated.

The objection has come as a surprise to many in the global investment community.

"China has been opening up their capital markets, and a net result of that is MSCI and other indices like FTSE are including them in broader global indices," Brendan Ahern, chief investment officer of Kraneshares, which runs several China ETFs, told me. "China has been opening up their markets, letting more foreigners participate."

Ahern noted that the process of excluding countries for practices that might not fit our country's standards could get very slippery. For example, the Emerging Market Index has a 4% weighting in Russia, and a 1.4% weighting in Saudi Arabia, both of which have state-controlled companies.

Ahern noted that state-owned enterprises were a common feature in the emerging market world: "Brazil, Singapore and much of the emerging market world have companies that are state-owned enterprises. China is not that much different than many emerging market countries."