- Discount to net asset value shrinks to 5.5% from 16% last year
- Fund has outperformed benchmark in past year after trailing it
Things are stabilizing for the world’s largest exchange-traded fund invested in Chinese mainland shares.
BlackRock Inc.’s iShares FTSE A50 China Index ETF has recovered most of the 22 percent loss it suffered in 2016’s first six weeks and is now down less than 3 percent. And the shares are trading at an improved discount of 5.5 percent to the fund’s net asset value, down from over 16 percent a year ago.
That in turn has helped slow a deluge of outflows from the ETF which began in November 2014 when China loosened restrictions on foreign ownership of so-called A shares, and the fund’s total assets plunged by two-thirds from an early 2015 peak before the hemorrhaging subsided in February. The reason: The ETF relied heavily on derivatives to mimic mainland returns, a pricier way to invest that suddenly became less necessary.
“Investors are less comfortable with an ETF structure when there is synthetic ownership, and there usually is a push from the investment community to fix whatever is causing the discount,” Mark Yusko, who invests in the ETF as chief executive officer of Morgan Creek Capital Management, said by phone.
That’s what BlackRock is trying to do with its ETF. The authorities’ move to grant an investment quota to open up the markets even further allowed the firm’s fund to increase its proportion of direct investment in A shares to 39 percent from 22 percent last August.
That has helped the fund outperform its underlying index by 12 percentage points on a total return basis over the past 12 months after trailing the benchmark by 26 percentage points the prior year, shrinking the net-asset value discount. The evaporation of the discount alone amounts to an effective gain of about $1.8 billion for investors in the $4.1 billion fund, data compiled by Bloomberg show.
Designed to mimic returns of the 50 largest companies traded in Shanghai and Shenzhen, BlackRock’s fund highlights how the long-term transformation of China’s markets can whipsaw managers as more efficient investment methods replace old ways of paying for access to the mainland’s $5 trillion stock market.
When the fund started in late 2004, a year before the mainland stock market started a sevenfold climb to its 2007 peak, derivatives known as China A-Share Access Products were virtually the only way overseas investors could bet on the equities.
“The fund’s prospectus states that it will seek to decrease the fund’s reliance on CAAPs to access the A-share market,” Anthony Arthur, a BlackRock spokesman in Hong Kong, said in an e-mail. “It has gradually become more physical as we have applied more investment quota to it.”
Its direct A-share holdings are made through quota programs known as QFII and RQFII, and the quota for the Shanghai-Hong Kong Stock connect. The QFII quota allotted to the fund stands at $970 million, according to the fund’s prospectus, while the RQFII quota is subject to change. BlackRock received $3 billion in RQFII quota capacity in May, which more than doubled the total amount of quota BlackRock can use to invest in mainland markets.
The asset manager hasn’t disclosed which ETFs will benefit from the increase. Allocating some of it to the A-share fund will further narrow the product’s discount to net asset value, said Stephen Tu, senior analyst at Moody’s Investors Service.
Increased direct investments aren’t completely responsible for the shrinking discount. Reduced volatility and the mainland market’s gradual recovery from last year’s crash has also helped, said Brendan Ahern, chief investment officer at KraneShares.
Before the 2014 announcement of looser restrictions and the opening of the Shanghai-Hong Kong exchange link, BlackRock’s fund traded at a premium to its net asset value most of the time and its total assets ballooned to over $9 billion. The assets continued mounting until peaking at $11.7 billion in January 2015. Fund managers pulled money from the BlackRock fund in 17 out of 22 months since the new rules were announced, and assets now total about $4.1 billion.
Other A-share funds were buffeted by the rules change. PowerShares China A-Share ETF was liquidated in March. Smaller funds such as VanEck Vectors ChinaAMC A-Shares ETF managed to adopt a direct-investment structure but its assets also fell, by more than 20 percent since the end of 2014. Trading volume in the W.I.S.E. - CSI 300 China Tracker ETF’s plunged, and its assets are down over 50 percent from last June’s high.
“In the house of mirrors that investing in China is, there is always another thing going on that has nothing to do with the economy or fundamentals whatsoever,” Eric Balchunas, an analyst at Bloomberg Intelligence, said by phone.
Money managers including Dan Draper, chief executive officer at Invesco PowerShares Capital Management, remain wary of the A-share ETFs. “We continue to watch the developments very closely, but we are not quite ready personally” to invest in them, he said in an interview in New York.
Some investors are dipping their toes back into the water, with 16 of 38 major money managers increasing or holding their stakes in BlackRock’s fund -- informally known as Asia’s SPDR S&P 500 ETF, after its biggest U.S. counterpart -- as of their latest filings.
“People gravitate toward where the liquidity is,” said Moody’s Tu. “So they’re going to go to the largest and most liquid product even though it may not be as efficient as a 100 percent physical ETF.”