Year of the dragon

As demand for access to China increases, the range of ETFs tracking this country is growing. Barney Hatt looks at the development of funds investing in Chinese securities

Prior to the introduction of ETFs tracking Chinese benchmarks, investors looking to capitalise on the country’s booming economy struggled to find efficient investment vehicles to gain exposure. Hong Kong listed companies and mutual funds were the primary choices. 

However, the recent and rapid expansion of single country ETFs has significantly broadened investor options. 

BlackRock’s iShares was first to introduce a China ETF in October 2004 tracking the Xinhua 25 index, listed in London. 

An ETF is a liquid and flexible tool to tap this country, especially as there are investment restrictions for overseas investors who do not have a Qualified Foreign Institutional Investors (QFIIs) licence. This is granted by the Chinese government to international organisations, allowing them to trade all Chinese shares types. 

Consequently, overseas investors can typically only invest in H-shares and Red Chip shares, which are listed on the Hong Kong stock exchange. However the advent of certain Ucits-compliant ETFs provides European investors with access to the performance of mainland Chinese securities. 

Over the last 12 months the continuing demand from investors for exposure to China from Europe has led to a significant increase in the size of assets under management (AUM) in China ETFs. Indeed assets in ETFs listed globally tracking Chinese benchmarks surpassed $32bn at the end of 2009, according to research by BlackRock. This figure is almost double the $15.9bn accrued in 2008. 

The firm’s China ETFs industry review says iShares is the leading provider with 11 China ETFs, 22 listings and $18bn in AUM as of December 2009.

According to statistics from Morningstar, the iShares MSCI China Index ETF is the second best performing product over one year ending 31 December 2009. The fund, which is listed on the Hong Kong stock exchange, has returned 69.49%.

Over a three month period ending 31 December 2009, Deutsche Bank’s db x-trackers HSI Short Daily ETF is the best performer, returning 14.99%.

Access to A-shares

Earlier in March, Deutsche Bank listed an ETF providing exposure to China on the Singapore exchange SGX, offering European investors access to mainland Chinese shares through a Ucits compliant structure. 

The China ETF tracks the CSI 300, an index measuring the performance of A-shares traded on the Shanghai or Shenzhen stock exchanges. A-shares can usually only be purchased by domestic investors, or foreign investors via the QFII system. As a result, this ETF provides European investors with efficient access to investment in mainland China. 

The underlying benchmark consists of 300 stocks with the largest market capitalisation and liquidity. The index is also quoted in renminbi, providing European investors with currency exposure.

In addition, the bank has issued an ETF tracking the MSCI Indonesia index on SGX and claims the China and Indonesia funds are the first db x-trackers listed on SGX for investors in Europe.

Deutsche Bank head of db x-trackers Asia Marco Montanari says the CSI 300 ETF has all in fees of 0.50% which is the lowest among China A-shares ETFs on offer, while the Indonesia fund will have an all fee of 0.65% per year.

Launched in July 2005, Lyxor ETF China Enterprise is one of the largest funds tracking a Chinese benchmark with $1.3bn AUM, as recorded at 12 March. Ranked ninth in terms of AUM over 12 months to 31 December 2009, the fund is up 64.3% in this period.

The ETF, which tracks the Hang Seng China Enterprises index, offers exposure to a basket of H-shares. These are securities of companies incorporated in mainland China, although they are listed and traded on the Hong Kong exchange rather than domestic Chinese exchanges. 

The fund is synthetically replicated, doing a swap with Société Générale to provide the performance of the Chinese benchmark. Instead of investing directly in a basket of H-shares on the Hong Kong stock exchange, the Lyxor fund invests in a basket of mainly European equities, which it swaps for the performance of the index. Société Générale is the counterparty for all of Lyxor’s funds. 

Lyxor director of ETF sales Claus Hein says: “A lot of investors have embraced the liquidity benefits of this product as you can trade H-shares directly on the Hong Kong stock exchange.”

He adds: “The total expense ratio of this particular product for example is 0.65%. So if you are looking to hold them for a year, you would expect most of the tracking error to be attributed to the total expense ratio.” 

Hein believes another key benefit of ETFs is they are good market access vehicles. He says: “You do not need to have a broker’s account in Hong Kong in order to be able to purchase this product.”

Hein adds: “A UK investor can purchase or sell an ETF directly on the London Stock Exchange in sterling or dollars. This means you do not need to have that much knowledge of the Chinese market if you want to diversify your portfolio with an allocation to China.”

Hein points out the Lyxor fund is Ucits compliant and has UK distributor status, which is important for capital gains tax treatment. The fund also trades in sterling. He says: “Some investors can trade outside their home market but being able to bring that liquidity on their local exchange in the local currency is definitely very helpful.”

Product issuers gain traction

As well as the leading issuer of ETFs tracking the region in terms of AUM and product number, iShares has achieved the highest average daily US dollar trading volume at $9.975bn with its FTSE/Xinhua China 25 Index fund, at the end of 2009. 

After iShares, the second leading issuer is China Asset Management, which offers two ETFs, two listings and has $3.8bn in AUM, at the end of December last year according to BlackRock.  

However, the firm’s report shows iShares has lost 9.2% in AUM market share over the year period, while China Asset Management gained 3.6%. 

The top 10 new ETFs listed in 2009 in terms of AUM include the WISE Polaris CSI 300 Investment Trust fund, the United SSE 50 China ETF, the iShares CSI 300 A-Share Index ETF and the iShares CSI A-Share Financials Index ETF.

The top 10 ETFs tracking Chinese benchmarks in terms of AUM at the end of 2009, comprise the iShares FTSE/Xinhua China 25 Index fund, the iShares FTSE/Xinhua A50 China Tracker, the China 50 ETF and the Hang Seng H-share Index ETF.

The report says there were 53 ETFs globally based on Chinese benchmarks, from 28 providers on 21 exchanges around the world at the end of last year.

The US has the highest AUM in Chinese ETFs with $12.47bn followed by Hong Kong with $9.97bn.

Click here for a table of China ETFs