Unless you’re into wonky financial stuff, it was an easy news headline to miss last week…

“China Will Be Part of a Popular Stock Index,” said the New York Times. London’s Financial Times called it a “Defining Moment for Investors.”

It all stems from a first-time-ever decision by MSCI, a U.S. firm that creates stock market indexes, to include several hundred of the largest publicly traded Chinese companies in one of its most popular benchmarks, the MSCI Emerging Markets Index. (You can also buy that index as the iShares MSCI Emerging Markets Index ETF [NYSE Arca: EEM].)

Fair enough, I say, except buying that index now (or any other that includes large-cap Chinese stocks) is pretty much like buying a U.S.-based technology exchange-traded fund, with all its risks…

Don’t believe me? The Nasdaq’s rise is dominated by the popularity of the so-called FANG stocks — Facebook, Amazon and Apple, Netflix, and Google.

The rise of popular large-cap emerging market indexes such as EEM, up 50% in the past 18 months, or the iShares MSCI China Index ETF (Nasdaq: MCHI), up nearly 60% in the same time frame, has been dominated by a quartet of highly popular homegrown Chinese tech companies.

I’m calling them, for bearish reasons, the Four Horsemen — Alibaba Group Holding Ltd. (NYSE: BABA), Tencent Holdings Ltd. (OTC: TCEHY), Baidu Inc. (Nasdaq: BIDU) and JD.com Inc. (Nasdaq: JD).

The rise of popular large-cap emerging market indexes has been dominated by a quartet of highly popular homegrown Chinese tech companies.

They’re getting pushed higher by the same powerful forces carrying the Nasdaq to its recent all-time highs.

But that’s a danger for any investor who’s concerned about large portfolio losses. Why? Most of us tend to think of overseas stocks as a venue to diversify our holdings; i.e., lower our risk.

Yet buying a large-cap emerging market ETF that includes these Four Horsemen means you’re just compounding the chances of taking a big loss when a correction or bear market comes. (I happen to think it’s a lot closer than most of us expect, but that’s another story.)

For instance, when looking at the MSCI China ETF’s portfolio, the Four Horsemen represent more than 30% of its entire portfolio value. The other 165 stocks take up the rest.

How many international ETFs hold each of these Four Horsemen?

According to ETF Channel

  • Baidu: held by 33 ETFs.
  • JD.com: held by 31 ETFs.
  • Alibaba: held by 30 ETFs.
  • Tencent: held by five ETFs.

Don’t get me wrong — these companies do represent, in many ways, the best of China’s 21st-century Internet capitalism. And MSCI is making the right decision in finally putting at least a relative handful of Chinese stocks in a widely followed benchmark such as the MSCI Emerging Markets Index.

But as one strategist told Bloomberg last week: “It’s risky when the whole market’s underpinned by a handful of [Chinese] large caps.”

Kind regards,

Jeff L. Yastine
Editor, Total Wealth Insider

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