Physical ETFs to ease access to China A shares

By:
Louise Bowman
Published on:

New funds to track both A50 and CSI300 indices; Ucits compliance opens funds to European buyers

Any concerns over a slowdown in Chinese economic performance or the impact of a reduction in US monetary easing were little in evidence when the first direct, physical replication ETFs tracking Chinese A shares in Europe were listed in London at the beginning of January.

Deutsche Asset & Wealth Management, together with Harvest Global Investments, listed the first ETF to offer direct replication of China’s CSI300 A shares index on the London Stock Exchange on January 16 – the db X-trackers Harvest CSI300 Index Ucits ETF. The ETF was launched on the New York Stock Exchange in November last year.

"The Chinese leadership is undertaking fundamental reform of sectors such as healthcare, education and entertainment and the CSI300 index is the way in which investors can catch the impact of that," Peng Wah Choy, chief executive of Harvest Global Investors, told reporters at the LSE as the ETF was launched.

Chinese ETFs to date have mostly offered synthetic replication rather than direct physical replication. Choy reckons that the cost of replicating access synthetically can be double the cost for a physical product.

By tracking the CSI300 index rather than the FTSE A50, the HSCEI or the FTSE China 25, Choy argues that investors in the ETF are offered more diversification and less reliance on the financial sector. The CSI300 index was developed in 2005 and tracks the 300 largest and most liquid shares listed in Shanghai and Shenzhen. The top 10 constituents comprise 22.8% of the index compared with 48.7%, 67% and 61.7% in the other three respectively. The index is 33.4% weighted in financial services compared with 61.5%, 61% and 53.9%. "If I was an investor I would not want to put 60% of my money in Chinese banks," says Choy.

The emphasis on the diversity offered by the CSI300 index is hardly surprising given that the ETF launched just days after competitor Source listed its physical A shares ETF, which tracks the FTSE A50 index. The CSOP Source FTSE China A50 Ucits ETF was launched on the LSE on January 9.

"Assets under management in China ETFs, including both A and H shares, represent less than 2% of all equity ETFs," points out Marco Montanari, head of passive asset management, Asia Pacific, at Deutsche Asset & Weath Management. "Foreign investors have a very small exposure to China. We wanted to be the first to offer access to China globally via an ETF, which is a very efficient and flexible way for investors to get exposure."

If the first two weeks of January are anything to go by, ETFs offering physical exposure to Chinese companies might come thick and fast in 2014. "To do this you need to be a global ETF powerhouse and have China expertise in RFQII," warns Montanari. "We are taking advantage of the structuring capability of Deutsche Bank and the expertise in China of Harvest."


The new ETF has an initial quota under RFQII of Rmb2 billion ($330.5 million). China operates two schemes via which overseas institutional investors can invest in Chinese stocks: the original dollar-denominated Qualified Foreign Institutional Investment (QFII) scheme and the renminbi-denominated RQFII scheme. RQFII was launched at the end of 2011.

At the beginning of last year the two schemes accounted for just 1.6% of the funds invested in the mainland’s renminbi-denominated A shares.

"The only real difference between RFQII and QFII is daily liquidity," says Choy. "QFII is for asset owners and RQFII is for fund managers. We can create products for investors that may not qualify for QFII so this opens up the whole China market to investors," he says. Harvest already runs RFQII ETFs in Hong Kong, but these funds are not Ucits compliant.

The lure of the European investor base is an understandable one for Chinese asset managers, but a partnership, at least at the initial stages, seems imperative. "We wouldn’t rule out setting up a Ucits platform, but the biggest challenge is distribution and branding," says Choy. "For most Chinese managers that come to Europe their main intent is to take the product back to China. If you want to distribute in Europe you have to get in front of investment advisers and bank distributors and you need a huge infrastructure to do that."

Choy says that after rapid growth in the domestic ETF market, real growth in the ETF business of Chinese mutual funds will now be internationally, with products such as the new London-listed funds. But he points out that other domestic products, particularly internet money-market products, will also see strong expansion. "This will be the next area of explosive growth and all players are getting involved," he claims. "AliPay [the online payment escrow service of Chinese online retailer Alibaba] now has $10 billion equivalent in one money-market fund."