I’m often perplexed at ETF market segments where investors continue to pour assets into certain funds when other options warrant more attention than the leading asset gatherer.
This often happens due to an ETF’s “first to market” status. Many funds are also overlooked with investors unable to keep pace with over 1,660 ETFs now trading.
But sometimes, investors may simply be misunderstanding the complexities and market structures of the countries they’re targeting.
Of all the single country segments in our ETF Classification System, I’m most baffled by the China total market segment.
I recently wrote about three overlooked emerging markets ETFs, but this time, I’m going to point out the most overlooked single country ETF: the Deutsche X-trackers Harvest MSCI All China Equity ETF (CN | F-80).
The “All-China” Conundrum
In my view, CN’s launch in April 2014 was historic, giving investors for the first time, full coverage of the Chinese equity markets in one ETF wrapper.
CN is currently the only China ETF that provides full beta coverage of the Chinese equity market. The fund tracks the MSCI All China Index, which includes all Chinese share classes, regardless of where shares are listed.
China ETF investing is still largely a tale of two markets: onshore and offshore (for details on China’s share class structure, see our 2015 China ETF Guide).
Therefore, ETF investors are mostly forced to decide whether they want to go the “offshore” route with ETFs like the SPDR S&P China ETF (GXC | B-32), or the “onshore” route with RQFII ETFs like the Deutsche X-trackers Harvest CSI 300 China A-shares ETF (ASHR | D-38).
The problem is, either route you go, you are leaving out a huge chunk of China’s massive total equity market cap.
Onshore vs Offshore
According to MSCI, the MSCI All China Index (standard index) has a total market cap of $2.35 trillion. The China MSCI A-share Index has a market-cap of $1.35 trillion, making up 57 percent of that. So, that means offshore-listed Chinese securities make up the remaining 43 percent.
The iShares MSCI China ETF (MCHI | B-29) has been the leading ETF in the segment for years, with $1.35 billion in assets. I’m constantly left wondering, why?
MCHI only holds Hong Kong-listed securities (its B-share exposure is miniscule), so it’s not even representative of China’s offshore market, let alone China’s full market. It’s ineligibility to hold US-listed Chinese firms means it can’t hold key Internet behemoths like Alibaba and Baidu.
(MSCI recently ruled that N-shares would be eligible in their global indexes, so MCHI is set to include N-shares in November 2015).
MCHI’s competitor, GXC--which offers comprehensive “offshore” exposure--has another $1.06 billion in assets. So between MCHI and GXC, there’s $2.37 billion in assets.
Yet, CN only has about $7 million in assets, or 0.2 percent of the $3.7 billion million in total assets in the China Total Market segment.
Just to put things into perspective how crazy this is, we’re talking about the 2nd largest economy in the world, and investors are still piling into funds like MCHI and GXC, which miss out on close to 60 percent of China’s float-adjusted equity market cap!
MCHI and GXC certainly make sense from a tactical perspective if you’re specifically interested in only the offshore market and trying to avoid the red hot A-share market (a perfectly legitimate concern, by the way).
But I sometimes wonder how many investors in MCHI or GXC are invested for the long-haul hoping to capture China’s broad stock market without being aware that they are missing out on more than half of China’s total market cap.
The Investment Case For CN
It’s easy to point out CN’s massive 20-25 percent outperformance against its peers since April 2014. But as we all know, performance is backwards looking and this chart could look different in the coming year.
But what’s relevant here beyond performance is that, as mentioned earlier, CN actually provides the whole universe of Chinese stocks.
Most passive investors in index ETFs simply want the broadest, cap-weighted beta exposure to invest along with the market, not beat the market.
When CN launched, I wrote about its partial “fund of funds” structure. For better or worse, I pointed out how using ASHR for its A-share exposure might pose a challenge for tracking because ASHR tracks the CSI 300 Index, instead of the MSCI China A Index.
Since then, CN has added the Deutsche X-trackers Harvest CSI 500 China A-Shares Small Cap ETF (ASHS | F-61) to help manage the fund’s tracking.
On the other hand, using existing ETFs for its A-share exposure has its benefits in terms of costs and market making.
The fund’s 0.71 percent expense ratio is less than the three available China A-share RQFII ETFs in the segment. Using ASHR and ASHS also simplifies the fund’s structure and helps from a market making and hedging perspective, since those underlying ETFs trade during US market hours.
Clearly, CN has challenges ahead. It only trades about $93,000 a day, and spreads average 14 basis points. But, its low liquidity is also a function of CN being overlooked.
A “One Market” China
I suspect that eventually, investors will see China as a “one-market” investment asset class. I wouldn’t be surprised if that happens when MSCI and FTSE include A-shares into their global indexes (A-shares are currently under review for inclusion by the two indexing giants).
CN is the full package. You get your China Mobile and Tencent Holdings through H-shares. You get your Alibaba and Baidu through N-shares. And, you get your SAIC Motor and Gree Electric Appliances exposure through A-shares.
CN isn’t a household name yet and careful trading is warranted until liquidity picks up, but from a comprehensive China beta coverage perspective in a single ETF wrapper, CN is a no-brainer.
At the time this article was written, the author held a long position in ASHR. Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.