The gradual opening of mainland China's securities markets to foreign investors hasn't exactly proceeded with the pace or liquidity that U.S. exchange-traded product investors have come to expect.
Still, a handful of ETP issuers expect that investors will look past current speed bumps and embrace exposure to A shares, equity securities traded on the Shanghai and Shenzen exchanges, as well as to China's fixed-income market.
According to research firm XTF Inc., 31 China-specific equity exchange-traded funds are listed in the U.S., accounting for just $10.1 billion in assets under management, compared with nearly $49.9 billion across 152 equity products offered in the Asia-Pacific region, mostly in Hong Kong, according to BlackRock Inc. Despite totaling $7.8 billion in assets, the three largest U.S.-listed China-focused ETFs now only invest in Chinese companies listed in Hong Kong or through American depository receipts. The aggregate market cap of A shares on Shanghai and Shenzen, however, is $5.4 trillion compared to $1.4 trillion for “China-related” companies trading in Hong Kong, according to the Hong Kong Stock Exchange's China Stock Markets Web.
While nearly 300 international institutional investors — including Yale University, the Bill & Melinda Gates Foundation and the Church Pension Group — have accessed the A-share market for several years under the $66 billion qualified foreign institutional investor program, the opportunity for fund managers to more widely offer access to customers wasn't available until the 2011 opening of the now 298 billion renminbi ($48.4 billion) renminbi qualified foreign institutional investor program, according to State Administration of Foreign Exchange announcements tracked by China-XBR.com.
The enhanced liquidity of the RQFII program — in which the quota is offered in renminbi as opposed to dollars — as well as the recently launched Stock Connect program between Hong Kong and Shanghai, gives ETP issuers and their subadvisers more depth in accessing the Chinese onshore markets. Yet, this hasn't made tracking those markets any easier.
“Capacity is an issue,” said Dodd Kittsley, head of ETF strategy at Deutsche Asset & Wealth Management in New York. The $789 million Deutsche X-trackers Harvest CSI 300 China A-Shares ETF, subadvised by Harvest Global Investments, Hong Kong, currently allows only five creation units (50,000 shares) per day, and has had to frequently update investors and market makers on its capacity constraints.
Limited creations can drive a high-demand ETF to trade at premium to underlying net asset value. According to ETF.com, the ETF, with the ticker ASHR, has experienced premiums as high as 7% in the last month as volume has increased. Moreover, premiums tend to collapse on significant selling pressure, exposing investors to declines due more to product structure than underlying prices.
“In some ways, these limitations are counterintuitive to what investors have come to expect from the continuously open offering of an ETF,” said Todd Rosenbluth, director of ETF research for S&P CapitalIQ in New York.
Jan van Eck, CEO of Van Eck Associates Corp., New York, which issues three China-focused ETFs under the Market Vectors brand, said the Stock Connect program, launched in November, significantly increases capacity for issuers looking to access the Shanghai market without a fund-specific RQFII quota. Stock Connect allows investors with access to the Hong Kong Stock Exchange to buy stocks listed in Shanghai, with a daily cap of 13 billion renminbi, collectively, and vice versa at a cap of 10.5 billion renminbi per day.
It's too soon to tell, however, how the program will affect cost and operations for DeAWM's ASHR and the $87 million Market Vectors ChinaAMC A-Share ETF, ticker PEK, which also tracks the CSI 300 index. PEK's smaller asset base and limited trading levels, relative to ASHR, have not driven it to as significant premiums as the larger fund, although trading spreads are wider and creations larger at 100,000 shares.
Critics of ETF product proliferation are quick to point out the overabundance of China-focused ETFs, including size- and sector-specific equity funds as well as recently launched toehold funds in the onshore corporate bond and commercial paper markets from Van Eck, Global X Funds, and KraneShares, separately. Market observers believe liquidity in China is high enough to offer numerous products, as mainland China features the world's third-largest bond market and more than $4 trillion in annual turnover (year-to-date) on both the Shanghai and Shenzen stock exchanges, according to the World Federation of Exchanges.
DeAWM's Mr. Kittsley counters that current and future growth of China's economy and financial markets indicate the country could soon be considered “its own exposure.” n
