The ‘next great superpower’ has gone from hero to zero in the space of just a few years. The China bears are now rampant and even my great old Aunt Hilda reckons that China is a credit-fuelled napalm bomb ready to explode! Boy these eighty-year-olds have a turn of phrase!

The potential inclusion of A shares in global indices could be catalyst to turnaround the fortunes of unloved Chinese equities.

If we track asset flows, China is about as unpopular as you can possibly get – tens of billions of dollars have been flooding out of Chinese equity mutual funds and ETFs into Japan, a fact that can’t have gone unnoticed by China’s benevolent and ever so nationalistic leaders!

Even Chinese investors have been demonstrating their ‘unswerving loyalty’ to the motherland by shipping unprecedented amounts of money offshore…or frankly anywhere but deposited in low yielding local savings accounts.

Lurking in the back ground is the BIG debate about the slowing rate of Chinese growth. At the end of last year of every year, everyone was worrying about 7.5% GDP growth rates, then it was 7% and now the bears have red pens out and are marking in 6%.

Luckily the Chinese authorities don’t appear enormously rattled at the moment and in fact seeming to be taking this unpopularity in their stride, busily enacting a whole slew of regulatory and capital reforms designed to make the economy work better.

But the bad news is that Western investors have all but abandoned the local Chinese stock markets, unimpressed by increasingly bizarre local share class rules and dreadful corporate governance. Even Anthony Bolton has just this week announced that he’s throwing in the towel on his Fidelity China fund – is this the final sign of a capitulation?

Perhaps not! I have a sense that Chinese equities could head even lower in the next few months. Looking at a stack of recent reports from the pointy heads at the big London investment bank research desks, we can see that Chinese equities remaining HUGELY unpopular. Take Morgan Stanley – at the beginning of June they ran their annual Global Investment Seminar which involved key institutional participants answering a series of key questions, most importantly “what is your preferred equity region for the next 12 months?” European markets were by far the biggest winner at 49% of all votes cast, with the US coming in at 23% and Japan (more on that country next week) at 19%. Poor old China lagged behind at a miserable 6%!

A cursory look down the long list of recent technical and fundamental data provided by quant analysts at French bank SocGen paints an equally depressing picture. Chinese stocks are down 13% over the last year with 2012 PE ratios at between 7 and 8 depending on your market or index, falling to just over 6 if you believe 2014 estimates. Those numbers are despite earnings per share growth expected to come in at 11.5% per annum in 2013 and a dividend yield on the market of between 4 to 4.5%. In fact, largely unnoticed by Western investors, China has been quietly turning into a dividend-focused market. Perhaps the most staggering number is that Chinese equities currently trade at 1.1 times book value.

So Chinese shares are cheap, but I suspect they’ll be getting even cheaper over the coming months. China is in profound bear territory and there’s little sign that it’s about to change overnight.  For a contrarian like me, this long list of solid fundamentals, dreadful technicals, and annoying government interference starts to add up to an increasingly convincing bullish, albeit contrarian, case. I can’t see any imminent market bottom, but I can absolutely believe that now is the time to start researching direct exposure to China. It may even be the time to start drip feeding money in to the country on a regular basis to take advantage of dollar cost averaging.

And if we look even further there is a powerful positive catalyst lurking on the horizon. Only last week for instance, analysts at Deutsche Bank provided an answer as to why contrarians might start buying – Chinese shares will increasingly feature in major indices, which will in turn be tracked a host of ETFs and passive mutual funds. In their latest special report entitled “China Equity Market Opening up to the World” from 12 June 2013 they observed that index firm MSCI has announced that “it will include China A shares in the review list for potential inclusion to its most tracked global benchmarks such as the Emerging Markets (EM) index. These global indices currently include only some of the Chinese corporate shares listed overseas and B-shares listed in China. MSCI will announce its decision in June 2014. If MSCI decides to include China A shares (likely in a phased approach), the first change could be implemented as early as May 2015″.

On paper this all sounds about as exciting as watching paint dry, but Deutsche is spot on when they observe that “the inclusion of China A shares [is] a milestone in the indexing world with significant and long-term impacts  [my emphasis]. The Chinese domestic equity market is the third largest in the world by total market capitalization. However, China remains underrepresented among global investors’ portfolios, mostly due to the foreign investment restrictions of A share market. In addition, current global benchmarks do not have a good representation of the sector composition shown in the A share market”.

The killer observations from Deutsche comes next,”We expect the foreign holdings of A shares as percentage of total A share market cap to reach 4% in 2016, from current 1.5%. Assuming a full inclusion of China A shares, China’s weight could increase from current 18% in the MSCI EM to almost 30% (from 2.4% currently to 4.2% in the MSCI ACWI). Based on the estimated assets benchmarked to major global indices (assuming these assets will be allocated according to the country weight in the indices), China could witness inflows of over US$180bn. In the medium to long term, Chinese equity market has plenty of room to grow, which could potentially attract US$500 bn to $1500 bn inflows”.

The big question then becomes how to actually implement a strategy of slowly buying into local equities. The big challenge for any western investor is that active fund managers are – by and large – pretty dreadful at adding value. That means you are probably best using an ETF, especially one that follows the right index at low cost. Fees typically range from about between 50 and 80 basis points. The bad news is that, although there are plenty of China ETFs, a lot of them do much the same and track H-Shares (i.e. Chinese companies incorporated in Mainland China but listed in Hong Kong). Among the biggest listed in Europe are the iShares FTSE China 25 ETF (FXC) at 74 basis points and the Lyxor ETF China Enterprise (HSCEI) (ASI) at 65 basis points.

For A-share exposure, you need to look to the db X-trackers CSI 300 ETF (XCHA) linked to the CSI 300 Index at 50 basis points. Personally, however, I’m more drawn to specific sector plays around this A-share index. In particular, I like Deutsche’s A-share consumer discretionary and bank sector ETFs, namely the db X-trackers CSI 300 Consumer Discretionary UCITS ETF (XCHD) and db X-trackers CSI 300 Banks UCITS ETF (XCHB) respectively.

For more information on these visit: db X-trackers lists China CSI 300 sector ETFs on Deutsche Börse and Chinese consumer ETFs well poised as China’s leaders look to boost domestic consumption.

Barclays and MSCI have launched a family of fixed income indices based on environmental, social and governance factors.

The indices, co-branded Barclays MSCI, combine Barclays’ experience in fixed income indices with MSCI’s strength in ESG analytics and represent the first time ESG considerations have been systematically integrated into bond indices.

The index family comprises more than 500 standard and bespoke indices representing the most widely used ESG strategies and investment objectives across three categories: Socially Responsible, Sustainability, and ESG weighted.

- Barclays MSCI Socially Responsible (SRI) Indices exclude issuers that engage in particular businesses activities that may be restricted for certain investors and are intended for investors whose investment selections are governed by values-based policies.

- Barclays MSCI Sustainability Indices apply a best-in-class methodology to select issuers (sovereign, corporate, and quasi-sovereign) with high ESG ratings relative to their peers. These indices are intended for investors who place a premium on companies’ sustainability strategies and believe ESG criteria can be applied to identify companies that are more effective in managing the ESG risks unique to their industry.

- Barclays MSCI ESG Weighted Indices use ESG ratings to systematically over- and under-weight issuers within a bond index using an objective rules-based approach. These indices are targeted toward universal owners whose investment strategies express a view on the financial impact that ESG factors will have on their investments.

These indices fill a critical gap in the market by providing asset owners and managers with ESG commitments, such as UN PRI (United Nations Principles for Responsible Investing) signatories, with a comprehensive series of performance benchmarks.

Additionally, institutional investors will be able to leverage these indices to create index-linked investment products, such as exchange-traded funds (ETFs), separately managed accounts, and structured products, based on ESG investment themes.

Waqas Samad, Head of Index, Portfolio and Risk Solutions at Barclays, said: “The Barclays MSCI ESG indices represent an important milestone in the growth of the ESG fixed income sector and reflect our ongoing commitment to expand our family of index products to meet the evolving needs of fixed income investors.”

Baer Pettit, Head of the MSCI Index Business, added: “We are very pleased to collaborate with Barclays to bring these innovative products to market. The new indices provide ESG investors with fixed income assets tools to support their asset allocation decisions, benchmark performance, conduct attribution analysis as well as the ability to offer active and passive funds. We expect the fixed income benchmarks to stimulate growth of ESG investment in this key asset class.”

Vanguard has expanded its ETF offering on the SIX Swiss Exchange.

Following this listing, a total of seven Vanguard ETFs are now available on the exchange.

All four of the newly listed ETFs are linked to FTSE indices. Three of the funds offer conventional broad market equity exposure to international developed markets, namely Europe, Asia ex Japan and Japan. The fourth tracks the performance of high-dividend yielding equities across both developed and emerging markets globally.

FTSE has been working with Vanguard globally since 2003 and is the index provider to a number of the firm’s most successful products, including the $71 billion NYSE Arca-listed Vanguard FTSE Emerging Markets ETF (VWO), the world’s largest emerging markets ETF.

All of the newly listed ETFs are physically backed and listed in Swiss francs (as are the existing funds), giving investors straightforward, local-currency access to these major equity markets and themes. And with total expense ratios (TERs) ranging from 0.15% to 0.29%, the new funds are among the cheapest in the market.

Axel Lomholt, Vanguard head of international product development and management, commented: “Continuing to list our ETFs on the SIX Exchange underscores our commitment to the Swiss market and the European market more broadly. Making our ETFs more readily available across Europe gives more investors a low-cost way to reach their investment goals.”

The extension of its ETF product line-up on SIX Swiss comes just two weeks after the firm listed products on the NYSE Euronext exchange in Amsterdam and Paris, and less than a month after it launched these latest four funds on the London Stock Exchange.

The rapid expansion and roll-out across these key European markets comes at a time when ETFs are fast gaining in popularity among investors of all types.

Vanguard’s SIX Swiss ETF line-up (all in tradable in CHF):

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Mark Wiedman, Global Head of iShares.

Growth in the US is expected to be primarily driven by increased ETF usage by existing and new investor segments, ETFs as core exposures and a widening investor base for fixed income ETFs.

Commenting on the projection, Mark Wiedman, Global Head of iShares, said: “In the last decade, ETFs have evolved from obscurity to a $2+ trillion industry, embraced by retail and institutional investors alike. But these are still early days in ETF adoption. Even in the most mature market, the US, there is an incredibly bright future.”

According to iShares, growth in the US ETF market will be primarily driven by six key trends:

1. Continued growth of the advised market: The continued growth of fee-based advisory and greater ETF adoption by financial advisors of all shapes and sizes is expected to continue to drive ETF growth in the retail market. Advisors blending active and index products together in a portfolio, coupled with end investors learning more about the benefits of ETFs and requesting these products from their advisors, are seen as being contributing factors.

2. Self-directed as the fastest growing portion of the market: With an addressable market of more than $4.0 trillion and a projected growth rate of 9%, self-directed investors should have a significant impact on ETF adoption and growth. The expansion of commission-free ETF platforms and marketing directly to the self-directed investor will likely also continue to factor in this growth trajectory.

3. Increasingly more institutional investors using ETFs in new ways: Existing and new institutional clients, particularly asset allocators, are increasing their investments in ETFs. Nine out of 10 institutional ETF users expect their level of ETF investments to remain stable or increase over the coming year, and half plan to increase their allocations by 2014. Institutions are also discovering how to use ETFs in innovative ways, leveraging their access and liquidity to meet their investment needs.

4. Retail and institutional clients adding ETFs for core exposures: To date, ETFs have largely been used to take a market position, but more and more buy-and-hold investors are using both equity and fixed income ETFs for core exposures. While this trend is at the beginning of the adoption curve, from 2011 to 2012 assets in core exposures grew nearly 30%, and 2013 is off to a strong start in flows.

5. The continued revolution of fixed income products: After more than a decade of continuous growth, fixed income ETFs are just starting to take their place as an essential fixed income capital market instrument. The US fixed income market is more than twice the size of the equity market, however, fixed income ETF penetration is only one tenth of the level of equity ETF penetration. Changing demographics, the ongoing evolution of the bond markets and greater awareness of fixed income ETFs from a wider investor audience will all lead to increased adoption.

6. New products and segments: There is a significant opportunity to expand the existing ETF market through new ETF products and new client segments. The next generation of ETFs should deliver innovative exposures, such as low volatility and term-maturity, as well as solutions-based products. New client segments such as banks and offshore investors are just starting to discover ETFs but will drive the next phase of growth.

Wiedman added: “Our industry has so much exciting work yet to do with clients – in placing ETFs at the core of portfolios, deploying ETFs in undiscovered ways, and expanding ETF technology into whole new swathes of the capital markets.”

Wiedman and the iShares team have also been positive on the European market. Back in April they released a statement predicting that the European exchange-traded product (ETP) sector – which includes exchange-traded commodities (ETCs) as well as conventional ETFs – will exceed $900 billion in size by the end of 2017, up from $387 billion at the start of the 2013.

Hector McNeil, Co-CEO of Boost.

Morgan Stanley becomes Boost’s sixth AP, alongside ABN Amro, BNP Paribas, Flow Traders, UBS and Virtu Financial.

APs undertake the responsibility of creating and redeeming units in an ETP in the primary market. In theory, a greater number of APs should lead to increased liquidity and tighter pricing for the ETPs assigned to them.

With physically replicated ETPs, APs create ETP shares – known as creation units – by assembling the underlying securities of the ETF in their appropriate weightings to reach creation unit size and then delivering those securities to the fund in-kind. In return, the AP receives ETP shares which are then introduced to the secondary market where they are traded between buyers and sellers through the exchange. APs also have the ability to redeem ETP shares through the same process in reverse.

With swap-based ETPs, this process typically works by creating or redeeming shares via a cash or in-kind basis using securities acceptable to the sponsor rather than the actual underlying.

Boost’s decision to expand its roster of APs comes at a time when short and leveraged ETPs are generating increased interest among investors of all stripes – private, intermediary and institutional – driven, in part, by the desire to move towards liquid, transparent and collateralised on-exchange alternatives to over-the-counter swap agreements and spread bets.

Indeed, the desire for more-robustly regulated products has been reflected in assets under management. According to a recent report by Boost, short and leveraged ETP assets rose by $5.1 billion (11.5%) in the first five months of 2013 to just shy of $50 billion. Globally, exchange-traded volumes have also increased for these types of products, increasing from $113 billion per month to $154 billion per month since 31 December 2012 to 31 May 2013, a 36% increase.

Hector McNeil, Co-CEO of Boost, said: “Boost is very happy and excited to welcome Morgan Stanley to our platform of ETPs and ETCs. Morgan Stanley are a world class ETF market maker who will enhance the liquidity of Boost’s products.”

He added: “Continuing inflows into the short and leverage ETP market show that short and leverage ETPs are useful tools for investors, not least because they can be used to hedge portfolios or profit in falling markets.”

Nasdaq OMX Global Indexes and Accretive Asset Management have announced a partnership to co-brand and develop the BulletShares target-maturity bond index range.

The indices, which have been co-branded Nasdaq BulletShares Indexes, currently have more than $2.5 billion in exchange-traded fund (ETF) assets linked to them – most notably under management by Guggenheim, a US-based ETF provider.

The indices, originally developed by Accretive, represent the performance of an investment in a diversified, held-to-maturity portfolio of fixed income securities with a common year of maturity. The concept combines the benefits of individual bonds and bond funds.

John L. Jacobs, Executive Vice President, Nasdaq OMX Global Indexes, said: “Accretive was quick to identify an opportunity in the bond index field and develop an innovative solution to meet the needs of investors with the first fixed-maturity corporate bond indexes. Nasdaq OMX is excited to partner with Accretive to expand the BulletShares brand globally and bring these indexes to investors around the world.”

Matthew Patterson, Accretive’s Managing Director, added: “We are excited about this new partnership with Nasdaq OMX, which has quickly emerged as a force in the global index arena. We strongly believe that Nasdaq OMX’s expertise, powerful brand and marketing prowess can take our innovative, first-to-market offering to another level of development.”

The existing BulletShares line-up includes 20 indices covering the investment grade and high-yield corporate debt markets, with maturities ranging from 2013 to 2022.

In addition to Guggenheim, ETF providers active in the target-maturity bond space include iShares in the US, and RBC and BMO in Canada. As yet, the concept has not been rolled out in ETF format in either the UK or wider Europe.

UBS’s new LSE-listed commodity ETF provides diversified exposure to 28 commodity futures contracts.

Based on the UBS Bloomberg Constant Maturity Commodity Index (CMCI) Composite, an index developed by UBS in cooperation with Bloomberg, the fund delivers access to 28 commodity futures contracts covering the energy, industrial metals, precious metals, agriculture and livestock sectors.

As well as offering exposure right across the commodity universe, the index uses up to five constant maturities (futures contracts are rolled on a daily basis to ensure that the average time-to-maturity of the contracts is constant) from three months up to three years. It thus reflects the complete pricing picture and all market opinions, whilst at the same time reducing negative roll returns.

Most conventional commodity indices are typically invested exclusively in short-term futures contracts and therefore consider only a small proportion of the commodity market. In a contango situation, this limited method inevitably leads to negative roll returns.

The individual commodities are weighted in the index according to economic and liquidity data. This weighting reflects the individual commodities’ global consumption patterns. The largest weights are in copper, WTI crude oil, Brent crude oil, aluminium and corn. Energy represents 36.7%, followed by agriculture with 28.4%, industrial metals with 24.8%, precious metals with 6.15 and livestock with 4.1%

The fund is UCITS IV-compliant and available in two share classes: share class “A”, which trades in GBp (British pence) and is aimed at advisers and retail investors, and share class “I” for investors looking to trade in larger volumes in USD.

The fund also maintains listings on the SIX Swiss Exchange, Xetra, Stuttgart Exchange and Borsa Italiana.

LSE listing information:

Source has added sterling trading lines to four US sector ETFs.

The new GBP products include the accumulating and dividend distributing share classes of the recently launched Source Morningstar US Energy Infrastructure MLP UCITS ETF and two of the provider’s largest US sector ETFs, the Financials S&P US Select Sector Source ETF and Technology S&P Select Sector Source ETF.

With the addition of these four funds, there are now eleven Source products available to be traded in GBP.

Ted Hood, CEO of Source, said: “ETFs are now attracting a wider group of investors in the UK. We are keen to offer access to key markets and interesting investment themes and opportunities in sterling, thereby avoiding the need for separate FX transactions.”

The Source Morningstar US Energy Infrastructure MLP UCITS ETF provides exposure to US energy infrastructure via the Morningstar MLP Composite Index. MLPs (Master Limited Partnerships) own and operate much of the US’s energy infrastructure and have attracted considerable attention in recent years.

The Financials S&P US Select Sector Source ETF and Technology S&P US Select Sector ETFs are among Source’s largest and most actively traded US sector products, with combined assets under management of $486 million. They provide exposure to the financials and technology sectors of the S&P 500 index, respectively.

Source’s new GBP listings:

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WisdomTree has listed an additional 12 ETFs on the Mexican stock exchange, the Bolsa Mexicana de Valores.

All 12 equity ETFs are listed in the special international section of the BMV, the Sistema Internacional de Cotizaciones (SIC).

SIC makes it possible for certain institutional investors to trade foreign securities in Mexico. Securities listed on the SIC are not publicly offered in Mexico.

Jonathan Steinberg, WisdomTree CEO and President, said: “We are pleased to cross-list an additional 12 ETFs on the Bolsa Mexicana de Valores and further expand WisdomTree’s exposure in Mexico and our relationship with Compass Group Holdings”.

Compass Group Holdings is an investment consultant and asset manager in Latin America. WisdomTree first teamed up with Compass back in October 2010 to market its ETFs in Latin America.

A total of 22 WisdomTree ETFs are now listed on the Bolsa Mexicana de Valores.

I think I owe readers an apology right at the beginning of this column – I am, I freely admit, something of an energy bore. In my Financial Times, MoneyWeek and Investment Week columns I’ve been banging on for what seems like an eternity about my structural bias towards the energy sector and, in particular, the energy infrastructure niche.

Source hits the spot with new US energy infrastructure play

Only this weekend, for instance, there I was regaling poor old MoneyWeek readers about the massive opportunity presented by the developed world’s need to retool and re-engineer its energy supply infrastructure.

So, given this tireless campaigning for energy-focused ETFs and funds, it won’t come as a great surprise to ETF Strategy readers that I think that Source, a London-based ETF provider, has done us all an enormous favour by listing Europe’s first MLP tracker structure.

In fact, I think it’s such a good idea that I’ve already bought a nice long line of shares in the fund. The fund in question is called the Source Morningstar US Energy Infrastructure MLP UCITS ETF and it is linked to an index of leading US-based energy infrastructure companies tracked, surprise, surprise, by Morningstar!

What may come as a greater surprise to ETF Strategy readers – given this rampant enthusiasm – is that I’m also willing to concede that now may not be the best time to actually buy this innovative new fund. In fact, I have a sense that this hugely popular sector in the US has probably overreached itself and could be due a small correction fairly soon. But my crystal-ball-gazing gifts and my abilities in market timing are so utterly lamentable that I’m willing to swallow any short-term volatility (over the next few months I’d guess) in pursuit of what I think should be a relatively steady long-term gain.

So, why the long-term bet on energy infrastructure? This isn’t the most appropriate space to bore you yet again with my views on energy, but I would make five simple arguments.

1. Everything that will happen for the good in the next few decades in the developing world will require an energy input of some sort and energy consumption will vastly increase

2. Alternative energy sources will emerge and US shale gas will make a huge impact on power generation and industrial use, BUT for the foreseeable future oil will remain the energy of choice for transport-based users, especially in the third world

3. Oil prices are volatile but they are trending higher over the long term as the cheap and easy-to-access stuff starts to run out. After every economic crisis, oil prices have reset to a higher level

4. New reserves of oil will emerge – no doubt about that – and I would argue we are not at the peak oil inflection, but new energy sources will require massive capital investment, especially in infrastructure, and will keep energy input costs high, requiring a decent profit margin for oil producers

5. As climate change rears its ugly head, we will desperately need a new energy infrastructure that will involve retooling our ‘soft’ knowledge about how to consumer energy (cue lots of innovations around energy usage). But it will also require a massive expansion in hard infrastructure, based largely around new grids, and massive new pipeline and storage networks

Given these long-term views – which, I will add, many very intelligent people violently disagree with – I think that a bias towards both a) strategic energy reserves owned by key companies as well as b) energy infrastructure build out and ownership makes sense!

There’s also the realty that in the core US market, tax-efficient income-orientated funds and structures such as Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs) (that own pipelines) and royalty trusts (which collect an income from oil and mining assets) are perhaps the DOMINANT equity income strategy for local investors. In other words, whereas here in the UK we buy shares in the likes of Vodafone or BAT to produce a growing dividend income, over in the US MLPs and REITs are the default structures for progressively growing equity income over time.

Cue the Source product based on the Morningstar index. The fund tracks the major companies in the sector based on their distribution yield, but the fund structure has an important and novel twist – it appears to be tax efficient for UK investors. One of the key drawbacks for UK investors in MLPs (or REITs for that matter) is that in order to implement an energy infrastructure strategy, we actually need to invest in US shares that pay a dividend. Those dividends are in turn subject to a withholding tax which is at either 30%, or 15% if you sign a US waiver form. That means the US Treasury gets a decent slug of your money even before you get it into a tax-efficient SIPP plan.

The Source structure does away with this tax treatment and in effect you receive the income as gross. The twist, of course, is that this is a total return swap, so the big investment banks behind the product do away with all that tax withholding nonsense and provide you with a total return IOU or swap i.e. we, the undersigned enormous investment bank, promise to pay you, the little investor, the total return on the index (including that income stream of growing dividends) in return for a swap fee (which was 0.75% the last time I looked) plus an annual fund fee of 0.50% per annum.

Obviously, that makes this structure a tad more expensive than your mainstream equity market tracker (total charges amount to 1.25%) but that treatment of the US tax is a big plus, giving UK-based investors a really simple structure to access this huge US sub-market. There’s also the obvious counterparty risk plus currency risk, as the underlying assets are US denominated – but, then again, I’d rather take dollar assets any day given the buoyancy of the US national economy.

All in all, the US energy infrastructure sector is an important play for ALL UK-based investors, so let’s hope that Source’s competitors now come up with new twists on the same idea!