ETFs: China’s latest craze
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Opinion

ETFs: China’s latest craze

As Beijing works to underpin the equity market, China's fund houses and investment banks are betting on exchange-traded funds as the next big thing. That reflects a market corseted by regulation, where limited options compel a collective herd mentality.

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China’s exchange-traded funds (ETFs) shrugged off the troubles of the country's broader equity markets and soared to an unprecedented Rmb2 trillion ($283 billion) in 2023, double the size of October 2020.

While active funds have floundered in the market downturn – with the CSI 300 index, which tracks the top 300 stocks on the Shanghai and Shenzhen exchanges, plummeting by 11% last year – ETFs have been jumped on by fund houses and investment banks that see an opportunity whose time has come.

One ETF executive, formerly of iShares in the United States and who has since taken the helm at one of China's premier fund houses, reflects somewhat ruefully on the evolution.

"I returned to China to work on A-share ETFs seven years ago, but it was too early,” he says. “Then, we were unrecognized trailblazers. Now, those seizing the moment are celebrated pioneers. It's all about timing."

Landmarks

The uptick in Chinese ETFs echoes regional disenchantment with the underperformance of active funds and the allure of lower-cost passive strategies.

In 2023, Asia outperformed Europe with an 18% growth in ETF assets under management (AuM), with passive ETFs in the region reaching $1.1 trillion by the end of September, according to Broadridge data.

But China's ETF landscape also aligns with the government’s agenda.  Last year's sector highlight was Huatai-PineBridge's CSI 300 ETF pushing past Rmb100 billion in AuM – a first for the industry.

Launched in 2004, this landmark fund is a collaboration between China's premier brokerage, Huatai Securities, and US asset manager PineBridge Investments.

The increase coincided with a broader uptick in activity. In August alone, the combined net inflows for the five largest ETFs hit Rmb90 billion – a surge that analysts at Goldman Sachs called "national team" buying.

The rapid growth of ETFs in China is down to their alignment with both state and investor agendas

In October, China's sovereign wealth fund, Central Huijin Investment, announced its purchase of ETFs and declared plans to increase holdings in the future.

Barclays' assessments suggest that the fund's October purchases could be around Rmb10 billion.

The market momentum has carried into 2024, with the Huatai-PineBridge ETF swelling to a new record AuM of Rmb150 billion. Wind data reveals that in January, the five largest broad-based ETFs – including Huatai-PineBridge's – captured net inflows exceeding Rmb130 billion.

“There have been signs recently that state-led buyers are purchasing ETFs tracking some key indexes in a bid to arrest the market’s decline, given surging turnover,” noted Barclays in a January report.

The term ‘national team’ was coined in 2015 to describe state-linked entities tasked with stabilizing the stock market during that year's market crash. Their efforts, however, fell short of averting a full-scale collapse. Despite the rapid rise of the Shanghai Composite Index from roughly 3,000 to beyond 5,100 points, the market fell swiftly, reverting to its baseline level by year's end – a stance it has held on to stubbornly since.

Market anchor

The efficacy of the national team is in the spotlight again. January saw a brief V-shaped rebound in the A-share market, spurred by aggressive ETF purchases, but the rally failed to gain lasting momentum.

Bloomberg reported a possible rescue package of Rmb2 trillion, potentially using state-owned offshore funds to buy onshore ETFs via the Hong Kong Stock Connect – but this persistent rumour lacks official confirmation.

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Carlos Casanova, UBP

“National team interventions may anchor the market at its current level, but seem incapable of propelling it beyond that threshold,” says Carlos Casanova, UBP’s senior economist for Asia.

The rapid growth of ETFs in China is down to their alignment with both state and investor agendas.

Often seen as a long-term investment tool, they are ideal for supporting market stability; for investors, they also offer an appealing avenue for short-term trading, thanks to low fees.

Limited alternative investment options also make ETFs attractive, while regulations on short selling, imposed on January 28, underscore a state preference for market-positive products.

Meanwhile, market consensus often sparks intense competition. The unveiling of a new index typically prompts a flurry of applications from asset managers eager to roll out corresponding ETFs. This rivalry has prompted a price war, initiated by E Fund late last year.

Yet, the ETF landscape remains vulnerable, mostly because barriers to entry are low.

China’s stock exchanges had greenlit brokers for market-making in 157 ETFs by the end of last year, with GF Securities out ahead with 282 funds.

However, local firms often bear the brunt of market volatility because they lack the sophisticated risk-management tools of their global counterparts.

For foreign investors, the undeniable appeal of China's undervalued stocks needs to be tempered with the knowledge that true investor confidence hinges on tangible economic signals, not just regulatory advocacy.

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