Chinese ETF Buyers Whipsawed Amid Widest Price Swings Since 2010

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U.S. investors pouring money into Chinese exchange-traded funds are finding it comes at a price: surging volatility.

ETFs that track Chinese equities on mainland, Hong Kong and U.S. bourses have attracted $1.1 billion in new money over the past month as the Shanghai Composite Index climbed to a seven-year high, according to data compiled by Bloomberg. The May inflows were second only to Japanese ETFs on American exchanges with the iShares China Large-Cap fund attracting $732 million, the most since 2012 and the biggest inflow among the 45 securities focused on Chinese stocks.

Foreign buyers, who seek to profit from a continuation of China’s world-beating rally, must navigate market volatility that is at the highest in five years and almost three times the level of U.S. stocks. The Shanghai gauge posted the steepest two-day retreat since 2009 last week after rising 143 percent in 12 months only to rally the most since January on Monday.

“There’s a lot of volatility right now, and we can expect it on a continuing basis,” Clem Miller, an investment strategist at Wilmington Trust, which manages $20 billion, said by phone from Baltimore on May 29. “Smarter investors are going to buy on the weakness as they expect China’s structural stock-market opening to continue, and the government introduces additional liquidity in the system.”

Exchange Links

Demand for Chinese equities has increased as the government cuts interest rates to stimulate growth and an exchange link between Shanghai and Hong Kong allows international investors wider access to onshore yuan-denominated stocks, or A shares. The government plans for a similar program with the Shenzhen exchange later this year.

China’s combination of inexperienced investors and leverage is a recipe for volatility, Michael-Douglas Lee, a Hong Kong-based trader at SG Securities Ltd., said last week.

New stock-account openings have surged at a record pace this year, while margin debt on the Shanghai exchange has soared more than 10-fold in the past two years. The Shanghai Composite’s 100-day volatility, a gauge of historical price swings, is at the highest level since January 2010 after surging to 32 percent on Monday. That compares with 12 percent for the Standard & Poor’s 500 Index.

The Shanghai Composite climbed 1.7 on Tuesday.

ETF Inflows

In the U.S., BlackRock Inc.’s $8 billion iShare Large-CAP ETF received $477 million last week, data compiled by Bloomberg. The Deutsche X-trackers Harvest CSI 300 China A-Shares ETF attracted $72 million in the five trading days and $160 million in May. The iShares MSCI China ETF pulled in $111 million last month.

Global funds investing in China added more than $4 billion in the week through May 27, more than double the previous record set in 2008, according to data provider EPFR Global.

The Shanghai gauge tumbled 6.5 percent on May 28 as brokerages tightened margin lending and the central bank drained cash from the financial system in its open-market operations. The index surged 4.7 percent on Monday to 4,828.74, after last week’s 1 percent decline.

International investors chasing the A-share gains may be getting ahead of themselves as the market digests its almost uninterrupted rally, according to Michelle Gibley, director of international research at San Francisco-based Charles Schwab Corp.

‘Cool Off’

“After the large gains in A-shares, a cooling off period is both necessary and healthy,” she said by e-mail on May 28.

Chinese authorities, who have cut interest rates three times in six months and added liquidity to the financial system by lowering lenders’ reserve requirements, are walking a fine line to curb excessive stock speculation. In addition to margin trading tightening, the securities regulator said May 22 it will target listed companies’ information disclosure and abnormal trading activities.

The iShares China Large-Cap ETF climbed 1.1 percent to $49.30 in New York on Monday, rebounding from a seven-week low last week. Deutsche Bank AG’s A-share ETF soared 5.4 percent to $52.63, halting a three-day slump.

“Nobody wants to be the last one on the ship, but at the same time no one wants to miss the extra rally,” Emma Dinsmore, chief executive officer of R-Squared Macro Management, based in Birmingham, Alabama, said by phone. “You are going to see a tremendous push and pull between bulls and bears as the market continues to progress. But so long as the government is willing to be accommodative, the shares have more room to run albeit at a volatile level.”

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