Steady easing opens doors

ETFs help investors cash in on opportunities on the mainland

PUBLISHED : Monday, 09 September, 2013, 12:00am
UPDATED : Monday, 09 September, 2013, 12:49am

With China continuing on a path of moderate economic growth, Exchange Traded Funds (ETFs) have helped a new generation of international investors gain access to investment opportunities, taking advantage of the country's stable economic development. It doesn't hurt that China has also pursued the gradual liberalisation of its financial services sector, which has made it easier for asset managers to create more, and better, safer and cheaper ETFs to access the market.

Today, there are more than 50 country, sector and strategy indices tracked by about 100 Chinese equity ETFs listed in different exchanges across the globe and freely tradeable by international investors, according to figures compiled by research firm Morningstar. They hold a combined US$28 billion in assets under management. On the mainland, around 60 equity ETFs listed on exchanges hold a combined US$23 billion. However, these are available only to domestic investors. This product choice is expected to continue growing.

With the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme expanding to London, Singapore, Taiwan and other locations, the market is expecting RQFII ETFs listed outside of Hong Kong to become available for the first time soon.

Meanwhile, in July, mainland authorities also raised the QFII quota to US$150 billion from US$80 billion, giving investment firms more room to create new products.

Volume-wise, the expansion of RQFII this year and the introduction of physical China ETFs, which invests directly in the underlying asset and are thus considered cheaper and less risky than their synthetic counterparts, in Hong Kong have helped to drive trading volumes of ETFs tracking the mainland market.

As a proxy, the average daily turnover of ETFs listed in Hong Kong - which corners the market for ETFs providing exposure to either onshore or offshore mainland equities - hit HK$4.5 billion in the first six months of 2013 from HK$2.5 billion a year ago, according to the Securities and Futures Commission.

And, while continuing concerns about the global financial crisis and worries about slower domestic growth have kept China equities down this year (Shanghai is down nearly 7 per cent year-to-date), there is optimism. A research report by S&P Capital IQ projects that Shanghai's A-shares index is set to rise by more than 16 per cent by the second half of the year.

Jackie Choy, ETF strategist at Morningstar and one of the authors of a guide on investing in ETFs on the mainland, says Chinese equity ETFs are a good way to access the mainland market for those who have made up their minds.

He says it is obvious investors will look to cash in on the country's economic prosperity, but for many outside the mainland, this is difficult because participation in the liquid domestic A-share market in Shanghai and Shenzhen is off-limits.

"Currently, investors cannot invest directly into the China A-share market. So it's only active funds in the market, RQFII ETFs or A-share ETFs, which can grant you access," he says.

Choy says the most important thing investors should keep in mind is that the mainland is still classified as an emerging market. Thus ETFs, like any investments investing in the country's financial markets, carry with them higher political, tax, economic and foreign exchanges risks than developed markets.

According to the Morningstar guide, those looking to invest in ETFs tracking mainland equities should note different funds invest in different classes of shares - from A- and B-shares listed on the mainland to H-shares, red chips and P-chips listed in Hong Kong - and thus have different risk-return characteristics.

In general, the report notes that risk-return profiles tend to fluctuate more between offshore indices because they invest in a wider range of mainland share classes. However, it also notes that onshore mainland indices have historically exhibited higher volatility but with lower returns.

Another thing to note is that trading hours and public holidays can differ for China ETFs listed in different markets. This difference is likely to affect short-term traders more than the buy-and-hold investors because the net asset value of the non-Asia listed ETFs are likely to take into account the expected effect of market news on equities when the Shanghai and Shenzhen markets are not open.

Finally, investors should also remember that funds tracking broad market mainland equity indices tend to be heavily weighted towards financial services, with typically between 30 and 60 per cent of holdings allocated to the sector - leading to some investors being unintentionally overexposed to the sector.