Why It's Crucial To Rethink China ETFs

July 09, 2014

In just the past year, the difference in returns between onshore and offshore China is staggering. Even though both the S&P and CSI indexes are “broad” benchmarks, the offshore market outperformed the onshore market by more than 25 percent!

1-Year Daily Correlations (7/4/2013 - 7/4/2014)

Index MSCI All China S&P China BMI CSI 300
MSCI All China 1 0.867 0.916
S&P China BMI 0.867 1 0.614
CSI 300 0.916 0.614 1

Source: Bloomberg

There are several reasons for the disparity in returns and low correlations between the onshore and offshore market.

The onshore market is still largely closed to foreigners, meaning it has a separate liquidity pool from global markets. Besides accessibility issues, many mainland-listed companies don’t list their shares overseas, and vice versa, so you’re looking at a different basket of companies as well.

The Offshore Market Twist

While breaking down China into the onshore and onshore market is the first step, there’s a twist within offshore ETFs that’s critical to understand. After all, 22 of the 28 China-focused ETFs listed in the U.S. target the offshore market.

Let’s look at the three largest and most popular “broad” China offshore ETFs: the iShares MSCI China ETF (MCHI | B-41), the PowerShares Golden Dragon China ETF (PGJ | A-22) and SPDR’s GXC.

Here’s a chart of their returns over the past year (July 3, 2013 - July 3, 2014):

China Fund Returns One Year

Charts courtesy of StockCharts.com

The simple explanation for this massive disparity in returns is that MCHI only holds Hong Kong-listed shares, whereas PGJ holds only U.S.-listed shares. Meanwhile, GXC holds both Hong Hong- and U.S.-listed shares.

Over the past year, China’s hottest sector was “technology.” I put technology in quotations because China’s tech space is still nascent, and the sector is dominated by Internet companies, practically all of which list their shares solely in the U.S.

The CSI Overseas China Internet Index is up close to 70 percent in just the past year! These Internet companies also happen to reach into the consumer sector due to the massive growth in China’s e-commerce market.


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