China A-Share Appetite Sends ETF Assets Toward Record

As traders in Hong Kong take advantage of a new exchange link to scoop up mainland Chinese shares, U.S. investors eager to join in the action are piling into the largest New York-traded A-share ETF, sending assets to a near-record.

Deutsche Bank AG’s X-trackers Harvest CSI 300 China A-Shares ETF, which invests directly in equities traded in Shanghai and Shenzhen, has lured $99 million this month, pushing total assets to $518 million, close to a record reached in September. The Market Vectors ChinaAMC A-Share ETF, the second-largest exchange-traded fund, drew $3.4 million on Nov. 17, the most in a single day since March.

The Shanghai A-share benchmark index has rallied 17 percent in the seven months since China announced the link between the Shanghai and Hong Kong bourses, giving international investors unprecedented access to about $4.2 trillion in stocks. Surging demand sent the premium to own the Deutsche Bank ETF over its underlying assets to a record last week and is forcing the fund to restrict new share creations as assets approach a $549 million government-imposed quota for buying onshore securities.

The inflows suggest the program “has at least raised the awareness of China A shares among investors outside China,” Qi Wang, a Hong Kong-based analyst with MSCI Inc, said in e-mailed comments. “Investors could view A shares as a potential risk diversifier as historically their returns have been uncorrelated with developed- and emerging-market equities.”

‘Great Signal’

International investors purchased 13 billion yuan ($2.1 billion) of Shanghai shares by 1:57 p.m. on Nov. 17, the first day of the link, triggering a halt in buy orders for the rest of the day.

Deutsche Bank’s CSI 300 China A-Shares ETF slipped 0.9 percent to $27.18 in New York yesterday, after closing at a record $28.25 on Nov. 14. Its premium over its underlying assets jumped to a record 4.1 percent last week, according to data compiled by Bloomberg. The fund’s total assets reached a record $525 million on Sept. 24. The Market Vectors ChinaAMC ETF fell 1.3 percent to $33.88 yesterday.

“The connect does a lot of different things, but primarily it’s a great signal to the marketplace at large that China is moving forward in terms of regulatory reform and opening up the market more and more,” Dodd Kittsley, the New York-based head of ETF strategy at Deutsche Asset & Wealth Management unit, said in a telephone interview yesterday.

The initial enthusiasm may be short-lived. Chinese stocks have dropped for five days and net purchases of mainland equities through the Hong Kong exchange link fell to 2.6 billion yuan today, down from about 4.8 billion yuan yesterday.

Asset Cap

As inflows surge, Deutsche Bank’s ETF, with a 3.36 billion yuan quota capping the amount of onshore assets it can buy, is fast approaching its limit.

Deutsche Asset & Wealth Management said earlier this month that beginning Nov. 24, the ETF would accept just one creation unit per day, similar to steps it took in September as inflows surged. A unit represents 50,000 shares, or about $1.4 million based on yesterday’s closing price. The fund has hit its current cap of 500,000 new shares, or about $14 million, seven of the past 10 days.

ETF managers who buy China’s domestic securities need a Renminbi Qualified Foreign Institutional Investor license, known as an RQFII. They also need to submit an application to China’s State Administration of Foreign Exchange for an investment quota.

Discount to Premium

Even though the fund can’t expand beyond the government quota, “investors keep buying, and they have to try and balance that,” Tim Mulholland, a managing partner at China-America Capital Co., said in telephone interview yesterday. “The problem with these ETFs, for investors coming in, they have to watch the liquidity mismatch.”

Shanghai-listed shares’ valuation discounts versus their Hong Kong counterparts have been disappearing, in a sign of investor confidence in the onshore market. The largest yuan-denominated stocks went from an 11 percent discount in July to a 2 percent premium yesterday, near the priciest level in 14 months, according to Hang Seng Bank Ltd.

“This link is evidence of one of the many reasons why it makes sense to invest in China,” Brian Jacobsen, who helps oversee $242 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin, said by phone. “Right now valuations look very reasonable, and this is just another step by the Chinese government that liberalizes their markets and their economy. This is one way, perhaps an easy way for U.S.-based investors to take advantage of that.”

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