2 China Shares Classes In One ETF

The latest China equity ETF to come to market does something new: It toggles between A-shares (securities of Chinese companies trading on the Shanghai and Shenzhen exchanges), and H-Shares (local securities of Chinese companies trading on the Hong Kong exchange), looking to own the cheapest share class of a given Chinese company at any time.

The CSOP China CSI 300 A-H Dynamic ETF (HAHA) looks to own the cheapest share class of a given Chinese company at any time. Hong Kong-based CSOP Asset Management is behind the strategy, which Matt Collins, head of U.S. Capital Markets for the firm, hopes will find a way into mainstream investors’ core portfolios.

ETF.com: One of your latest ETFs toggles between China H-shares and A-shares regularly. Tell me how that works, and why it makes sense to invest in China that way.

Matt Collins: In the U.S., the bulk of assets, the cash flow and interest have been focused on Hong Kong shares, particularly in funds like the iShares China Large-Cap (FXI | B-36). As the spread between A-shares and H-shares became wider and wider this year, there was a tremendous amount of cash flow into FXI, and some other H-shares products. That’s been the legacy way of investing into China, even though it's not necessarily giving you access to Mainland China.

That’s also been popular with a lot of investors, because the Hong Kong shares trade tremendously cheaper to their A-share equivalent onshore. And there's only so much “selling” you can do of A-shares.

So we launched the CSI 300 product for long-only clients as sort of a gradual step into China, where it's giving investors access to both markets. The way it works is that, if A-shares are trading on average 30 percent, sometimes 40 percent—more expensive to H-shares—we swap out the shares if there's a dual listing between the two classes to the “cheaper” share class. I would say there are about 57 out of 60 names right now in the mix that are dual-listed that are cheaper in the “H” category.

ETF.com: Does it make sense to have exposure to both H-shares and A-shares markets? If you own a security that’s listed both ways, you're still getting the same exposure at the end of the day, but for a different price point? Is there a difference in terms of risk profile?

Collins: We haven’t really seen the two securities act in the same manner, and that's primarily based off of market structure. In China, the equity market is enormous. It's the second-largest out there. But it's also fairly insular, where it's mostly mainland Chinese trading China equity. So, it acts differently than most developed markets, and even other emerging economies.

Hong Kong-listed shares act very much like a developed economy would, with strong institutional demand. Even if it's called “China,” the correlation to mainland China is about 0.65. It's correlated, of course, but it's weak, and much weaker than I think most people expect a product that says “China” to act relative to mainland China.

From our perspective, there's a fit for both shares. Whether you're owning just an H-share product or just an A-share product, I think there's a fit in the portfolio for both. But if you're looking to access China, I don't think there's any question that the A-share offerings out there are a better way of accessing it, just because it’s a different market and I think that's what a lot of people are coming to realize.

ETF.com: As the mainland market opens up, should we expect this disparity between A-shares and H-shares to disappear over time?

Collins: Over time, we expect that spread to collapse. And then, you would have valuation differences that are a bit more temporary. Right now, any time an investor hears there's a spread or an arbitrage opportunity, the assumption is that it lasts less than a second, or maybe a few weeks, if it's in the fixed-income or high-yield space. Most spreads collapse fairly quickly before investors can capture it.

In this case, you have some structural issues where there's just not a natural two-way flow between markets. As Hong Kong accesses China with more ease, and as mainland China money starts flowing out, you would expect that spread to collapse, and then the differences wouldn't last quite as long. But that could take a substantial amount of time.

ETF.com: Where does HAHA fit in a portfolio? Does it replace something or complement other strategies?
Collins: We built the product to be a core holding for investors who either don't have a view on A- versus H-shares, or they don't care to take one. It's really a core holding that's capturing both markets.

And for investors who do have a view and feel strongly for H-shares, this product is a way of maintaining your correlation to the Shanghai Composite for mainland China while still getting access to those undervalued classes.

ETF strategists that we've talked to, and hedge funds that pay attention to these things, were telling us, “I'm not going to buy an overvalued market when there's an equivalent that's cheaper off shore.” This product is essentially doing that work for them. It rebalances once a month.

ETF.com: You've been vocal about making sure we don't characterize this fund as a “smart beta” strategy. Why is that so important for you?

Collins: We see this as a core China holding for investors. There's been so much proliferation of active/passive strategies, if you will, as people look for ways of actively managing a portfolio, but they push it out in index form for a broader appeal. But the complexity is still there when you're doing that, particularly on smart beta or fundamental-based strategies.

We want to make sure that when you're managing China equity, we want to be as transparent as you can, because that market is difficult to trade, and because a lot of investors are just getting used to it. We don't want to add layers of complexity around it.

Contact Cinthia Murphy at [email protected].