Crashing the Communist Party With China A-Share ETFs

Photographer: Tomohiro Ohsumi/Bloomberg

A global stock market indices board near a taxi stand in the Lujiazui financial district in Shanghai. Close

A global stock market indices board near a taxi stand in the Lujiazui financial district in Shanghai.

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Photographer: Tomohiro Ohsumi/Bloomberg

A global stock market indices board near a taxi stand in the Lujiazui financial district in Shanghai.

One of the final frontiers of investing may provide investors with some old-school value plays.

Until last year, U.S. investors had no direct access to the universe of 2,500 stocks that trade solely in mainland China. The stocks, called China A-shares, have generally been available only to Chinese citizens. They represent $4 trillion in market capitalization and make up two-thirds of China’s stock market. Only 100 of them are also listed on the Hong Kong exchange, which makes them somewhat easier for foreign investors to buy.

ETF issuers are starting to help open up this market to more institutional and retail investors. They're teaming up with Hong Kong companies that China allows to trade a limited amount of A-shares. It's the start of a long effort by the Chinese government to attract foreign investors, which now make up 1 to 2 percent of holders.

In October China will allow Hong Kong brokers to take buy and sell orders for 568 A-share companies, but only from Hong Kong investors and only up to $210 million a day. It's a small but positive step. The hope is that more such steps will eventually lead the big global index providers to integrate A-shares into their indexes, which would increase demand.

For example, A-shares could eventually be a 10 percent weighting in the MSCI Emerging Markets Index, according to MSCI. The index has $1.4 trillion of assets that use it as a benchmark. That means over $100 billion worth of demand could come from being included in that one index, albeit incrementally. It won't start soon: MSCI and Standard & Poor's recently said they wouldn't include the shares in the index because of the restrictions on trading shares.

On a valuation basis, the Shanghai Shenzhen CSI 300, which tracks the 300 largest and most liquid A-shares, looks cheap. The average price-earnings ratio is about 10. That's well below the price-earnings ratios of the S&P 500 Index and the MSCI Emerging Markets Index, which are 18 and 17, respectively. On top of the CSI 300's lower price-earnings ratios, its shares are trading, on average, at the lowest discount in eight years when compared to mainland China shares traded on the Hong Kong exchange, called H-shares.

One advantage of China A-shares is that they don't move in line with the U.S. market. In investor-speak, there's no correlation with U.S. stocks. In comparison, over the past 10 years the correlation of the U.S. market with the H-shares in the MSCI China Index was 0.70, and 0.35 for the MSCI Frontier Markets Index. Lack of correlation has become increasingly difficult to find in this connected world.

There are obvious risks to A-shares. There are the overall worries about the Chinese government's unpredictability. Some investors shy away from investing directly in China because of concerns over corporate governance and accounting. There's also the fear that China's economy will suffer a sharp slowdown after a period of rapid growth. And some of the hottest Chinese tech plays, including Alibaba Group Holding Ltd.'s coming initial public offering, are not A-shares but U.S.-listed Chinese stocks.

The first China A-share ETF to physically hold the shares came out last November. There are now four, and 15 in registration with the Securities and Exchange Commission, according to ETF.com. The products have been slow to attract money, as investors don’t know much about this new area, and because China A-shares are down 7 percent so far this year.

Here's a look at the available options:

db X-trackers Harvest CSI 300 China A-Shares Fund (ASHR)

This was the first A-share ETF to market when it came out in November. The $210 million ETF tracks the Shanghai Shenzhen CSI 300. The financial sector is that index's heaviest allocation, at 38 percent. ASHR, which is down 8 percent so far in 2014, charges investors 0.82 percent of assets annually. DB recently launched a small-cap sequel to ASHR, the db X-trackers Harvest CSI 500 China-A Shares Small Cap Fund (ASHS).

Market Vectors ChinaAMC A-Share (PEK)

PEK does the same thing as ASHR and has the same return for the year to date. It's significantly smaller, at $24 million, and slightly cheaper; it charges investors 0.72 percent of assets annually. Market Vectors is coming out with a mid- and small-cap A-share ETF called the Market Vectors ChinaAMC-ChiNext ETF (CNXT). It starts trading July 24.

KraneShares Bosera MSCI China A Shares (KBA)

KBA differentiates itself by offering broader exposure to A-shares. It holds 442 stocks, including more mid- and small-caps. The fund, with just $3 million in assets, charges investors 0.85 percent of assets annually. It launched in March and its performance is flat for the year.

Investors can also buy an all-China ETF that tracks A-shares along with all the other types of shares. There's only one on the market -- the db X-trackers Harvest MSCI All China Equity ETF (CN), which launched on April 30.

More stories from Eric Balchunas:

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Eric Balchunas is an exchange-traded-fund analyst at Bloomberg. More ETF data is available here, and weekly ETF podcasts can be found here.

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