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By David Stevenson –
What’s your A-shares strategy like? I ask this rather obscure question because it seems like everyone in the world of exchange-traded funds (ETFs) is obsessed with the coming deluge of China A-shares ETFs. It is, I am reliably told, a BIG THING! My guess is that within a year, no self-respecting ETF issuer will be caught dead in public without a China A-shares product up their sleeve!
Over in the US, Deutsche Asset & Wealth Management (DeAWM)’s db-X ETP platform and its local Chinese partner Harvest Global Investments have kicked off the fun and games with the first US-listed A-shares ETF and I am dependably informed that within a few months we should expect at least an additional three or four rivals to emerge (including potentially products from KraneShares and Market Vectors).
Why should we care as investors? In simple terms, we shouldn’t! Now, I’m not going to deny that the rise of China A-share ETFs is without merit, nor that you shouldn’t spend a quiet few minutes perusing the funds and examining the key arguments – hopefully carefully shepherded together in this short article – but for most mere Western mortals, I’d argue that the debate about whether “To A-share, or not to A-share” is almost entirely irrelevant, largely because although you may be buying into a bunch of proper, locally listed and held shares, they are still the wrong set of shares to own…in an A-share form or H-share form or frankly any other variation thereof that includes a silly letter in front of it!
So before we get to the issue of A-share versus the Rest, let’s recap one key argument: if you are a contrarian, now is the time to be buying into Chinese equities. I’ve been quietly banging the drum for Chinese equities for at least six months and I think the writing is now on the wall…and what a long wall they have to write these positive arguments!!!
All manner of well adjusted, ‘normal’ investors have started accepting that Chinese shares are cheap. Up till now they’d largely avoided taking the plunge because they wanted to hear what the Chinese Communist Party’s latest plenum was about to say about …well…frankly everything including whether China will revert to some kind of Maoist nightmare. The result of the ‘reforms’ package deserves an article on its own, but the bottom line is that Xi Jinping is very definitely in charge. And while he is absolutely no Gorbachev in the making, it is clear he will make the decisions that count, aided by a much more streamlined, technocratic government.
As this change at the top sinks in, I’d expect ETF and fund flows to reverse course, and investors to wake up. Crucially, the slower growth of the economy is actually good news for three reasons:
- It signifies a determination to correct major systematic imbalances (which are far from being thoroughly reformed, even after the plenum);
- It suggests a much bigger role for domestic consumer demand, which is good news for equity investors;
- Last but by no means least, capital efficiency is becoming paramount and leading state businesses are being encouraged to be more sparing in their use of state cash. This goes hand in hand with a more pronounced emphasis on dividends.
Overall, I think these arguments all provide a strong optimistic narrative for local Chinese equities, although quite whether it’s enough to stir the domestic investor base out of their lethargy is an entirely different question!
So, to return to our core argument, I’m no China bear – quite the opposite in fact. But given this bullish position, shouldn’t I be racing out to buy these new fangled A-share ETFs and sell my more conventional H-share holdings in indices such as the HSCEI (for Hong Kong-listed stocks), MSCI China or the FTSE China 25?
On the positive side, the pre-eminent local A-share index, namely the CSI 300 Index, the underlying to DeAWM’s ETF, offers a number of obvious benefits including:
- A more diversified index of 300 stocks which means that the investor gets a less concentrated set of big mega cap stocks;
- A greater role for smaller, genuinely private-sector companies, although investors shouldn’t fool themselves into getting carried with this argument as the vast majority of big stocks are still state controlled;
- Reduced exposure to the banking and energy sectors, with a combined share of around 30% for the CSI 300 index as opposed to over 80% for an index such as the HSCEI index.
These are all interesting observations which might excite quantitative analysts but for the rest of us I suspect they’re not really that important. If we want Chinese exposure, frankly all we need is a broad enough set of big companies in an easy-to-trade index.
Now it’s at this point in the argument that a more nuanced, qualitative set of ideas emerge, focusing not just on local markets (which can be tracked by ETFs that use derivatives, usually swaps, to build exposure) but on those hugely important A-share classes.
Locally owned and listed A-shares incorporated on mainland China and traded on the Shanghai and Shenzhen exchanges are notoriously difficult for foreign investors to access. Put simply, it’s nearly impossible for non-Chinese investment firms to buy A-shares unless they’ve been lucky enough to be granted status as a qualified foreign institutional investor, typically via the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme. Until recently, foreign investors had to make do with buying into shares listed on offshore exchanges, such as in Hong Kong, Singapore, London or the US.
Cue DeAWM and its first ETF in partnership with Harvest. Their brand new ETF, the db X-trackers Harvest CSI 300 China A-Shares Fund (ASHR), is currently the only ETF listed in the US that can invest directly in physical A-shares. Launched in November 2013 and with more than $200 million in assets already, this fund, its fans argue, allows investors a much broader opportunity set than just H-shares, especially those companies with a consumer and domestic focus.
The DeAWM and Harvest also make another really important argument, that – and here I quote them – “most global benchmarks currently include relatively few Chinese equities, but that could change. In June of 2013, MSCI and FTSE announced that they are considering the addition of China A-shares to their most tracked global benchmarks. That would be a milestone in the world of equity indices and the exchange-traded funds (ETFs) that track them. Assuming full inclusion of China A-shares, China’s weight in the MSCI Emerging Markets Index could increase from 18% to almost 30%.”
The chart below from DeAWM nicely sums up this argument. Buy Chinese shares because the rest of the world will have to buy them in the future, if the major indices change their composition rules.
On a tactical level, the market in the US seems to have taken very favourably to this ETF and trading volumes look to be fairly healthy.
So am I convinced? No! I entirely accept and applaud the index argument that Chinese shares are under owned, but frankly that speaks to all major Chinese equity indices. I’m also heartily in support of the argument that you should buy a particular set of companies on local exchanges, i.e. domestic, consumer-focused businesses controlled by private enterprise and not under the CCP’s thumb. All of this is absolutely spot on, but that’s not actually what you get with the CSI 300 index. The index’s long list of A-share companies are still largely focused on financial services companies, with large caps in the ascendancy, and state control very much in evidence. When you buy the CSI 300 index you are buying into many more companies, in a less concentrated index to be sure, but not enough to make a massive difference, especially when it comes to expenses, which in the case of the ASHR fund are over 1% per annum. I’d also note in passing that local investors – who dominate the onshore markets such as CSI 300 – are still a notoriously fickle, bearish bunch who haven’t been keen to chase up local share prices. In fact, the CSI 300 index has been a relative dog of an index when compared to its peers.
My sense is that local investors still need to be convinced that the recent plenum reforms actually amount to something really important – until they do, they’ll probably stay on the side lines, keeping local markets under-valued. When that domestic sentiment turns, I’d absolutely be watching A-shares and local markets, but until then I’d be more inclined to pick my indices and sectors very carefully, focusing on those companies with a strong domestic/consumer/private enterprise/mid-cap flavour.
The views and opinions expressed herein are the views and opinions of the author, David Stevenson, and do not necessarily reflect those of ETF Strategy.