The hefty premium on ‘PEK’ makes the difficulties of investing in mainland China plain as daylight.
The Market Vectors China ETF (NYSEArca: PEK), the pioneering fund New York-based Van Eck Global launched almost two months ago to give U.S. investors exposure to mainland Chinese firms, is trading at a double-digit premium to its net asset value due to limited access that foreign investors currently have to so-called A shares.
The 13.5 percent premium, as of Tuesday, Dec. 7, betrays the difficulties of investing in mainland China—which had been off limits to noninstitutional equity investors until PEK’s launch. The fund has gathered almost $20 million since its Oct. 13 launch, and demand continues to outstrip supply being made available to foreigners by the Chinese government.
“There’s a premium based on the availability of the A-shares, so it’s very hard to create,” said Richard Keary, principal at New York-based Global ETF Advisors LLC, an ETF industry consultancy that helps bring exchange-traded products to market. “And if it’s hard to create, then you’ve got to have this premium.”
Keary said the only way the premium would come down is if demand for the ETF and other A-share investment vehicles decreased, or if Chinese restrictions on ownership of the shares diminished. He noted A-shares are so popular because investors believe mainland China, as opposed to Hong Kong, truly reflects the potential of the Chinese growth story.
An official at Van Eck stressed that it can do creations to expand the fund, but that currently it has become expensive to do so. That distinguishes PEK’s premium from one a closed-end fund might have, because closed-end funds, unlike ETFs, have a fixed number of shares.
The Van Eck official, Adam Phillips, a managing director in charge of ETFs, also reaffirmed statements in the fund’s prospectus warning investors that PEK was likely to trade at a premium because of the way the ETF is structured. The premium was as high as 15.5 percent last Friday, according to data compiled by IndexUniverse.com.
Phillips said PEK uses total return index swaps created by a counterparty that has been approved by the Chinese government as a “qualified foreign institutional investor.” So-called QFII status, which Van Eck has applied for but hasn’t yet received, gives access to the A-shares market of companies listed on either the Shanghai or Shenzhen exchanges.
The Chinese QFII program is limited in size, which at times makes creating exposure through swaps expensive enough to cause the ETF to trade at a premium.
“Right now, there’s tons and tons of demand for A-shares access, and QFII quota is extremely tight,” Phillips said.