China ETF in U.S. Loses Most Money as Mainland Brokers Buy

The biggest Chinese exchange-traded fund in the U.S. is losing money faster than any other country- focused ETF, even as the lowest valuations since 2008 convince brokerages in the Asian nation that it’s time to buy.

Investors pulled a net $961.2 million from the iShares FTSE China 25 Index Fund (FXI) this year, the most among 140 single-country ETFs that trade on U.S. markets, according to data compiled by New York-based research firm XTF Inc. The outflows coincided with a decline in the Shanghai Composite Index’s price-earnings ratio using estimates for the next year to 11.6, a valuation last seen during the financial crisis in November 2008.

Valuations in the Shanghai Composite slumped after the country’s central bank raised lender reserve requirements 12 times since the start of 2010 and increased benchmark interest rates for the fourth time. The People’s Bank of China is tightening monetary policy to curb inflation, which climbed to the highest level since July 2008 in May.

China’s been too popular and money’s starting to flow out,” said Kenneth Fisher, who oversees $44 billion as chief executive officer of Woodside, California-based Fisher Investments Inc. “It’s outside China where the interest has been focused and primarily in America. People were tripping over themselves to get into Chinese equities and now, they’re starting to get scared.”

Second-Half Rally

Mainland brokers say that the lowest multiples since economic growth collapsed three years ago will lift equities. Beijing-based Citic Securities Co., the nation’s largest brokerage, and China International Capital Corp. both predict the Shanghai Composite will rally in the second half as the government sustains economic growth by easing monetary policy.

U.S. investors aren’t convinced. FXI, which is listed on the New York Stock Exchange’s Arca platform, has fallen 0.3 percent in 2011 amid concern the country will struggle to control inflation, as well as increased regulatory scrutiny following accounting problems of Chinese companies listed in North America. The China-linked security tracks China’s largest 25 stocks on the Hong Kong exchange.

At the same time, money managers in the U.S. are favoring the world’s second-biggest emerging market, pouring money into the largest Brazil ETF. About $1.43 billion went into the iShares MSCI Brazil Index Fund (EWZ) this year. The Shanghai Composite Index has advanced 0.3 percent in 2011, while Brazil’s Bovespa index has retreated about 9 percent.

Driving Flows

“It’s certainly counterintuitive because you’re used to thinking that performance drives money flows in and out,” said Nicholas Colas, the New York-based chief market strategist at BNY ConvergEX Group LLC. “China is raising interest rates and that’s caused money flows out of the country, while the underlying index has been generally fine. It’s declined but it’s not like it’s down 10 percent.”

China’s stocks rose today, driving the benchmark index to the highest level in six weeks, after Premier Wen Jiabao said inflation will be controlled and services industries expanded at the second-fastest pace this year. The Shanghai Composite Index added 0.1 percent. Brazil’s Bovespa fell 1.3 percent at 4:09 a.m. New York time.

While developed equity markets and other emerging market stocks have struggled this year, the ETFs tracking some of these countries have managed to attract U.S. investors. The iShares Brazil ETF had the sixth-biggest inflows this year, while falling 4.5 percent.

Japan Wins Money

The single-country ETF that lured the biggest investment this year is the iShares MSCI Japan Index Fund (EWJ), which drew $2.63 billion in assets as it declined 3.4 percent. FXI has lost about $564.5 million in the past three months, XTF data show.

“We’ve seen heavy selling the last few weeks,” said Eric Lichtenstein, the Jersey City, New Jersey-based managing director of ETF trading at Knight Capital Group. The China ETF’s outflows may be due to the “overall negative view of equities,” he said.

Concern about the Greek debt crisis and the end of the Federal Reserve’s stimulus measures in the U.S. have spurred investors to sell equities globally. The MSCI All-Country World Index of developed and emerging markets has slumped 3.4 percent since climbing to a high of 357.72 on May 2.

Guggenheim China Fund

The market capitalization of all 26 exchange-traded funds that track only China is about $10.2 billion, according to XTF data. Investors have withdrawn $1.04 billion from the group this year. The Guggenheim China Small Cap ETF (HAO) saw the second-biggest outflows out of China-focused ETFs, losing $122 million.

Economists predict China’s expansion, which has averaged more than 10 percent during the past decade, may slow to 9.5 percent this year, according to the median estimate in a survey by Bloomberg.

Fisher said money managers may be wary of China’s economy as economists and investors warn of a property bubble in the region. Standard & Poor’s on June 15 cut it outlook on Chinese developers, echoing concerns by bears such as hedge fund manager Jim Chanos. New home prices rose in 67 of 70 of China’s cities in May.

U.S. investors may be partly exiting Chinese equity funds after reports that companies from Longtop Financial Technologies Ltd. (LFT) to Sino-Forest Corp. (TRE) were exaggerating operations, Colas said.

Inflation, Accounting

“The fundamental problems China has -- controlling inflation, its monetary policy -- are more important drivers but it can’t help,” he said. “It’s definitely a concern. Accounting is always a concern.”

While investors have grown bearish on China, the outflows for FXI may be also driven by a decline in short interest in the country’s equities, according to Lichtenstein and Colas. The short-interest ratio for FXI sank to 1.42 on June 15, the lowest level in more than a year and after rising to a record 3 in February, according to New York Stock Exchange data.

Large orders of ETFs are made through authorized agents who purchase blocks of the underlying holdings and trade them with the fund to create new shares. Investors betting on declines may still need to create shares of the ETF in order short the funds.

To contact the reporter on this story: Inyoung Hwang in New York at ihwang7@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net

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