Investors Flee China Onshore ETFs In 2015

August meltdown and government intervention cool once-hot market.

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Reviewed by: Trevor Hunnicutt
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Edited by: Trevor Hunnicutt

(Reuters) – The lopsided performance of exchange-traded funds tracking China's turbulent domestic markets is stanching the flow of new money into a market that once excited investors.

Investors pulled $418 million out of ETFs tracking Chinese stocks that trade on the Shanghai and Shenzhen exchanges in the year to Dec. 21, withdrawals representing more than half the total assets held in those funds, according to FactSet Research Systems.

Over the same period, ETFs tracking Chinese stocks not traded on the mainland attracted $1.2 billion.

Triggered By Summer Meltdown

Much of the outflows came during a late-summer rout of once-high-flying stocks that exposed issues with government intervention, corruption and strict regulations for foreign investment.

Moves by China's government to restrict trading on domestic exchanges have sometimes blocked index funds from buying the stocks they need to replicate the performance of Chinese benchmarks.

When China halted most trading on its onshore exchanges in July, for example, the largest A-Shares fund, the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | F-54), was thrown so far off track that its losses for the year at one point doubled the index's.

Since then, A-shares ETFs have managed to rebound, delivering an average of 0.7% in returns for the year to Dec. 21, compared with the 2.5% loss averaged by other Chinese stock-tracking funds, FactSet says.

ASHR has also improved its performance—the value of the fund's shares traded on exchanges increased 19% over the 12 months ended in November, compared with the index's 24% return, Deutsche data shows.

Concerns Have Not Lifted

Despite the resurgent performance, lingering concerns are preventing the funds from taking off.

On Monday, the ASHR ETF paid investors $8.43 for each share held, about a quarter of what they are worth. Such so-called distributions are viewed negatively by investors, who must pay taxes on the earnings.

The distributions were likely tied to heavy redemptions by the fund's investors this year, which sometimes force the sale of stocks held by the fund, according to Todd Rosenbluth, U.S. director of ETF and mutual fund research at S&P Capital IQ.

When funds sell assets that have gained value, they have to pay those earnings out to investors.

China A-Share ETF Closing

PowerShares said earlier this month it will shut down its China A-Share Portfolio (CHNA | D-31) in March.

Representatives for Deutsche Bank AG and PowerShares owner Invesco Ltd. did not respond to requests for comment. In an earlier statement, PowerShares said CHNA's closure would "align its product line with the changing investment landscape."

The weak sales of ETFs tracking Chinese A-shares come despite performance that bests their traditional counterparts. Other Chinese ETFs often track shares of companies that trade outside mainland China, in places such as Hong Kong.

2015 Top-Performing ETF: CNXT

One top-performing fund, the Market Vectors ChinaAMC SME-ChiNext ETF (CNXT | D-48), has returned 52% over the year to Dec. 22, according to ETF.com.

The fund focuses on privately owned firms, as opposed to Chinese state-owned enterprises, in sectors such as information technology and health care.

"At the end of the year, we're still going to see these products being the best performers," said Rosenbluth. "My fear would be investors in these products not fully understanding the risks tied to a still-emerging market."

More China Onshore Funds Coming

Nonetheless, ETF companies are pushing forward with new products in the hope that China's markets will offer investors more diversified portfolios and access to quick growth in the world's second-largest economy.

A decision last month by MSCI to add Chinese companies listed in the United States and elsewhere, such as Alibaba, to its indexes was also seen as improving investors' exposure to China's growth.

Vanguard Group is currently adding A-shares to its $34 billion Vanguard FTSE Emerging Markets (VWO | C-86). Deutsche is planning more A-share products, as are BlackRock’s iShares and other issuers, according to U.S. regulatory filings.

A Vanguard spokesman said Chinese markets have proven easy to trade in and described the fund's transition to A-shares as going "exceptionally well."

Trevor Hunnicutt is a staff writer for Reuters.