China ETFs struggle to meet demand

iShares A50 ETF was most traded security in Hong Kong last month

An exchange traded fund tracking mainland Chinese equities became the most traded security on the Hong Kong exchange in January, the latest sign of international appetite for exposure to China and the growing interest in Asia for passive investments.

The iShares A50 ETF, which aims to mirror the performance of China’s top 50 listed companies, last month recorded a higher turnover value than any listed stock in Hong Kong, including index heavyweights such as China Mobile, HSBC, and ICBC.

Since the start of December, the CSI300 index – a mixture of Shanghai and Shenzhen listed stocks, also known as A shares – has risen more than 30 per cent, drawing a wave of foreign interest in Chinese equities, both into active and passive funds.

“Starting from early December when the rally really kicked off we saw steady interest from investors,” said Nathan Lin of eFunds, who manages a Rmb10bn ($1.6bn) ETF that tracks the CSI100 index. “There may be a pullback in the short term, but this year will definitely be better than last year. Once we see the turnround in the economy, and a recovery in corporate earnings, we will see a further rally in A shares.”

ETF trading volumes in Hong Kong have risen almost fivefold since July, as an improvement in Chinese economic data drove international investors to seek exposure to mainland stocks. January marks the first month on record that an ETF has topped the most active list, as compiled by Hong Kong Exchanges & Clearing.

Direct exposure to Chinese equities is highly restricted via a quota system called the qualified foreign institutional investor (QFII) scheme. Those limits make it difficult for many global funds to buy Chinese shares directly. A separate quota – the renminbi qualified institutional investor (RQFII) scheme – allows Hong Kong subsidiaries of Chinese money managers to access onshore assets.

Although overseas investors can buy shares in Chinese companies listed in Hong Kong, known as the H-share market, ETFs are an increasingly popular way to get exposure to stock market performance in Shanghai. The iShares A50 fund is a synthetic ETF, which invests primarily in derivatives.

The challenge now for providers is how to meet demand. Mr Lin said eFunds exhausted its latest additional RQFII quota of Rmb5bn, granted in December, in just five days.

During 2012, investors put $25bn into China-related ETFs, second only to US funds, while six of the 15 most successful new passive product launches of the year were A-share trackers, according to iShares.

ETFs remain a small part of Asia’s investment landscape, accounting for about 6 per cent of regional assets. But the market is the fastest growing for ETF providers. In 2012, Asian ETF assets rose 50 per cent, compared to an increase of 29 per cent in the US and 24 per cent in Europe.

“We believe that China has the largest growth potential in the ETF space given its opportunities for new providers and products”, Deutsche Bank said in its annual review of exchange traded products.

Two other ETFs were among the top 20 most active securities in Hong Kong in January, one tracking the Hang Seng index, and a second mainland share tracker.

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