China A-Share ETFs Tsunami Coming

RQFII genie's out of the bottle; be prepared for a China A-share ETF frenzy in 2014.

RQFII genie's out of the bottle; be prepared for a China A-share ETF frenzy in 2014.

Renminbi qualified foreign institutional investor (RQFII) ETFs are a new breed of funds in the U.S., capable of directly holding mainland China-listed “A-shares,” as opposed to using derivatives to capture the fairly restricted market.

The RQFII program allows Hong Kong-based companies to raise capital (renminbi) outside of China, and directly buy shares listed in Shanghai and Shenzhen.

Now there’s a tectonic shift occurring, with ETF issuers in the U.S. teaming up left and right with Hong Kong-based companies with “RQFII status” as their subadvisors to launch physically backed, A-share ETFs in the U.S.

Let’s start with Deutsche Bank, which tapped Harvest Global Investments as its subadvisor to successfully launch the first RQFII ETF in the U.S. last November, the db X-trackers Harvest CSI 300 China A-shares Fund (ASHR). Most impressive, ASHR was seeded with more than $100 million and it already boasts assets under management of $207 million.

Soon after, Van Eck turned its formerly swap-based China A-Share ETF into a physically backed fund by teaming up with China Asset Management (AMC) as its subadvisor. Van Eck also renamed its ETF the Market Vectors ChinaAMC A-share ETF (PEK | F-49). PEK, which was granted an initial quota of 1 billion RMB ($165 million), tracks the same index as ASHR, the CSI 300 Index.

But that’s just the beginning.

We also have newcomer KraneShares, which teamed up with Bosera Asset Management, with a planned RQFII ETF slated to track the MSCI China A-shares Index. Like PEK, KraneShares’ fund, the Bosera MSCI China A Share ETF (KBA), was awarded an initial RQFII quota of 1 billion RMB ($165 million).

Source, a leading ETF provider in Europe, who barely beat out db X-trackers to launch the first RQFII ETF in Europe, is also expected to launch an RQFII ETF in the U.S. Source is teamed up with CSOP Asset Management, and its CSOP Source FTSE China A50 ETF will track the large-cap-focused FTSE China A50 Index.

So what does all this mean for U.S. investors?

It means now that these issuers have established relationships with their respective subadvisors in Hong Kong, you can expect a flood of ETF launches in the coming years.

The filing front has literally been bombarded by new RQFII ETF filings in just the past few months. Even though I work in the industry, it’s making my head spin just trying to keep up with them!

Besides the two products already launched, we now have more than 15 RQFII ETF filings, which include seven sector funds and two small-cap funds (listed in table below). Db X-trackers and Van Eck have been the most aggressive in their filings for RQFII ETFs.

There’s a lot to digest here, so I’ll give you my quick 2 cents on what I think about all this.

I think sector and small-cap funds are always useful as tactical plays or complements to your portfolio, so their existence is welcome.

For example, db X-trackers’ small-cap ETF will be based on the CSI 500 Index, which will provide an entirely different exposure (away from financials, which dominate the FTSE A50 and CSI 300 Indexes) to mainland Chinese small-cap firms that aren’t included in any ETFs at the moment.

Certain sector funds also look promising. Db X-trackers’ suite of sector funds will consist of companies from the broader CSI 800 Index, which includes the CSI 300 and CSI 500 Indexes. I’m especially eyeing the consumer-focused ETFs, as well as the health care ETF.

The Holy Grail Of China ETFs

Still, there are two filings I’m most excited about, which I consider to be the holy grail of China ETFs.

That’s the db X-trackers MSCI All China ETF (ASHA), which will track the MSCI All China Index, and the Market Vectors All China ETF (which doesn’t have an index assigned to it yet).

With these new funds, for the first time ever, investors will have an ETF inclusive of all Chinese share classes (A, B, H, Red Chips, P-chips, N) that will capture ”total China.” (Our white paper on Chinese share classes is helpful for those interested.)

These would be the first of its kind to provide broad beta coverage of the total Chinese market, and the most practical ETF to hold for any core China exposure in your portfolio.

Buying a broad-based China ETF today is akin to buying a U.S.-focused ETF that only holds stocks listed on specific exchanges. Some ETFs that capture all “investable” shares even exclude N-shares, which is like buying a U.S. ETF that excludes Google, Facebook, Twitter, Yahoo and the rest of the Internet pack.

Currently, investors are forced to go the “onshore” route with ASHR or PEK, or the “offshore” route with funds like the iShares MSCI China ETF (MCHI | B-40) or the SPDR S&P China ETF (GXC | B-42).

One way or another, you’re missing out on companies that don’t dual-list their shares on multiple exchanges. To get the most comprehensive coverage, you need to buy an “onshore” ETF together with one of the “offshore” ETFs.

While the race is on to launch the first comprehensive China ETF, I think db X-trackers has some serious momentum behind them with the massive success of ASHR, not to mention the prowess of an MSCI index in their hands.

But the question now remains: How will the domestic Chinese equity market perform in the coming year, and will its performance live up to the hype around RQFII ETFs?

At the end of the day, even if you’re finally getting physical exposure, if the underlying market is crumbling, investors aren’t going to be happy, and it’ll show in the funds’ asset flows.

Still, these are exciting times for those looking to broaden, or even “complete” their exposure to the Chinese equity markets.

In the meantime, try not to get overwhelmed, or tempted to chase every launch. Sit back, relax, do your research and enjoy all the innovation.

US RQFII ETF Filings

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.