China A-Shares No ETF Game Changer

February 26, 2014

China A-shares in a broad emerging market fund may be the right idea at a terrible time.

Plans to bring to market the KraneShares FTSE Emerging Markets + All China ETF are interesting in one sense but ill-fated in another. Here’s why.

Just like adding a superstar to a team doesn’t make it an automatic contender, adding China A-shares to a broad emerging market fund, in my opinion, is no game changer for investing in the developing world.

In other words, the design of KraneShares’ new fund is interesting and potentially useful for passive investors. But the timing could hardly be worse.

What I mean is that this KraneShares fund is likely to come to market at a time when investors are pulling record amounts of money from broad emerging market funds like the iShares MSCI Emerging Markets ETF (EEM | B-100) and the Vanguard FTSE Emerging Markets ETF (VWO | C-89).

According to the preliminary filing detailing the KraneShares FTSE Emerging Markets + All China ETF, the fund will track a new FTSE index that includes both traditional emerging markets investing exposures as well as the China A-share market—arguably the holy grail of China equity investing.

(For a full appreciation of the complexity of China’s equity market, refer to ETF.com’s “The Complete Guide To Chinese Share Classes.”)

The Good News

So, first, let’s start with the positives.

Using ETF.com’s ETF Analytics to see country exposure in the two largest broad emerging market funds, EEM and VWO, leads to a quick and clear conclusion: China is quite underrepresented.

To be clear, despite being the second-largest economy globally, China occupies less than 20 percent by weight in either EEM’s or VWO’s portfolio.

This phenomenon is largely due to strict capital control imposed by the Chinese government—the domestic Chinese equity (A-shares) market is still largely inaccessible to foreign investors.

Because many large Chinese companies are listed solely in the A-share market, indexes that exclude the A-share market don’t quite provide an accurate representation of the larger Chinese equity market.

Thanks to the recent expansion of the renminbi qualified foreign institutional investors (RQFII) program—U.S. investors finally have direct access to the Chinese A-share market via U.S. listed ETFs—the db X-trackers Harvest CSI 300 China A-Shares Fund (ASHR) and the Market Vectors China AMC A-Share ETF (PEK | F-46).

However, investors looking for broad-marketlike EM exposure are still left unsatisfied by existing broad emerging market ETFs. Here comes KraneShares FTSE Emerging Markets + All China ETF.

The fund will track the FTSE Emerging + China All Share Class Index, which expands the existing FTSE Emerging Index by adding China A-Shares.

By leveraging its existing relationship with Bosera Asset Management in Hong Kong, KraneShares will have access to RQFII quota, hence access to the highly restricted and coveted A-share market. As such, the fund can track a more inclusive emerging market index.

This is good news for passive investors looking for broad and representative emerging market exposures.

Rather than holding EEM or VWO and adding some long positions in ASHR, investors can get broader and more diversified emerging market exposures by holding only one fund. It’s quick and easy.

 

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