The first RQFII A-Share ETF, namely the ChinaAMC CSI 300 Index ETF (83188), was listed on the Stock Exchange of Hong Kong on 17 July 2012. The ETF had assets under management (AUM) of Rmb3.8 billion (~US$600 million) prior to listing. The ETF tracks the CSI 300 Index, and is managed by China Asset Management, the largest Chinese asset manager as measured by assets under management.
According to a report by the Ming Pao Daily, 3 other Chinese ETF providers, E Fund, CSOP Asset Management (a subsidiary of China Southern Fund Management), and Harvest Fund, are planning to launch another 3 RQFII A-Share ETFs in the near future. These ETFs will track the CSI 100 Index, the FTSE China A50 Index and the MSCI China A Index. Here we provide a quick examination on these indices’ key features and discuss the “do’s” and “don’ts” of investing in these RQFII A-Share ETFs.
After closely scrutinising the differences amongst these various indices, we suggest that investors who are anticipating a rebound in the Chinese economy should consider an ETF tracking one of the broader indices with a greater number of constituent stocks, such as the CSI 300 Index and the MSCI China A Index. These indices are less exposed to the financial sector and are more broardly representative of the composition of the Chinese economy. For investors with a more positive take on the financial sector within China, we suggest they consider an ETF tracking an index with a smaller number of constituent stocks, such as the FTSE China A50 Index and the CSI 100 Index, given these indices’ larger degree of concentration in the financial sector.
Notes: These index candidates are as reported by the media and therefore the ETFs’ actual benchmark indices and the versions thereof could vary.
Meet the Indices – FTSE A50 China Index, CSI 100 Index, CSI 300 Index, MSCI China A Index
Regular readers may recognise the following summary from our article “Picking the Right Chinese Dishes from the ETF Menu”. Here we examine the indices that either are or will potentially be tracked by the RQFII A-Share ETFs:
.png)
● The number of constituent stocks within these indices ranges from 50 to 540. The fewer the constituent stocks, the greater the index’s concentration is in the financial sector (which includes the real estate sector, while Chinese banks have the highest proportion). The financial sector has the highest weighting amongst all equity sectors within all 4 indices, ranging from 31% to 62%.
● Indices with fewer constituent stocks have outperformed over the trailing twelve months, but have underperformed over the past 3 years. We believe this can be attributed to the performance of the financial sector. In particular, we note that the CSI 300 Financials Index outperformed the CSI 300 Index over the past year, but has underperformed over the trailing 3 years. This comes as little surprise given the FTSE China A50 Index’s relative degree of concentration in the financial sector (over 60%) versus the MSCI A Share Index (around 30%). In recent years, the degree of correlation between the CSI 300 Financials Index and the FTSE China A50 Index was relatively higher (99% for both the trailing 1 and 3 year periods) than the level of correlation between the financial sector benchmark and the MSCI China A Index (87% over the past year and 91% over the prior 3 years).
● From a risk perspective, as measured by standard deviation, there are no particular trends or significant differences worth noting amongst the 4 indices. However, it is worth noting that those indices with a greater number of constituent stocks will include small/mid-cap stocks which could be less liquid, which could potentially result in greater tracking error relative to those ETFs tracking indices with fewer, larger components.
RQFII A-Share ETFs: “Do’s”
DO form your investment thesis: In addition to forming an investment view on the general A-Share market, investors should also form a view on the significant sectors that the ETF is exposed to. In particular, we found that the financial sector is one of the key performance drivers for all of the relevant A-Share indices.
DO understand the indices: Investors should understand these indices' construction, including the index constituents and their weightings, and be aware of any sector or single security concentration. This will allow investors to understand whether the ETF in question is an appropriate instrument with which to execute their investment thesis.
DO read the prospectus: The ETFs’ prospectuses contain important information regarding expenses, tax treatment, investment restrictions, and many other operational aspects which investors should be aware of before making an investment decision.
DO care about the total expense ratio (TER): Multiple studies by Morningstar and academics have shown that a fund's expense ratio is the most reliable predictor of its future success.
DO understand capital gain tax treatment: Different accounting treatments of potential capital gains taxes on A-Shares can have different impacts on ETFs’ performance. For a more detailed discussion of potential capital gains tax issues embedded in these ETFs, please refer to the section “Potential Risks in ETFs with a “China” Label” of our “Picking the Right Chinese Dishes from the ETF Menu” article.
DO evaluate the ETF’s performance after listing: After the ETFs are listed on the exchange, investors should continuously review how well they track their benchmark indices and whether there is any consistent premium/discount between the ETF’s market price and its net asset value (NAV). Note that premiums could result from a disruption to unit creations in the event of a manager’s inability to increase its RQFII quota in a timely fashion.
RQFII A-Share ETFs: “Don’ts”
DON’T forget the risks:
● Renminbi (RMB) – RQFII A-Share ETFs are priced in RMB and traded in RMB. Investors are required to have sufficient RMB in order to trade the RQFII A-Share ETFs. However, investors should note that RMB is currently not freely convertible and is subject to exchange controls and restrictions. In particular, retail investors are restricted to an exchange limit of RMB 20,000 per day. That said a lot of retail investors may have already accumulated some savings in RMB. RMB deposit in Hong Kong totaled RMB 554 billion as of end-May 2012, according to the Hong Kong Monetary Authority.
● RQFII Quota – The RQFII ETF managers are subject to RQFII quotas. In the case that a manager’s quota is reached and additional RQFII quota is not granted or not granted in time, unit creations could be disrupted and the ETF could trade at a premium.
● Differences in exchange trading hours – The A-Share markets close at 3pm while the Stock Exchange of Hong Kong closes at 4pm and there are also differences in public holidays to consider. These differences will inherently “create” premiums and discounts between the ETFs’ market price and NAV. However, as we’ve seen elsewhere in the world, in these instances, the ETFs can act as a type of price-discovery mechanism.
● Trading band limits in A-Shares – Investors should note that the A-Share market is subject to a 10% intraday trading band for ordinary stocks (5% for some specific types of stocks), while stocks traded on the Stock Exchange of Hong Kong--including the RQFII A-Share ETFs--are not subject to such a limit. If and when A-Shares that are constituents of these ETFs’ benchmark indices reach these limits, it will likely result in premiums or discounts between the ETF’s market price and its NAV. This is another instance where the ETF may function as a sort of price-discovery mechanism.
Jackie Choy is an ETF Strategist with Morningstar.
