In the wake of sharp drop in VIX-related exchange traded fund prices, investors have become aware of the potential pitfalls premiums may pose on any exchange traded fund investment. One particular China ETF has been trading at elevated premiums since its inception, but it has only recently started to fall back down.

The Market Vectors China ETF (NYSEArca: PEK) previously traded at a premium of around 10% to its net asset values at the end of March. As of April 20, the premium has dropped to 1.37%. [How ETF Premiums and Discounts are Caused]

“PEK trading an elevated premium to its NAV in the past was not a function of it not being able to create and redeem shares as was the case with TVIX,” Chris Hempstead, head of institutional sales and trading at WallachBeth Capital, said in a MarketWatch article. “There are completely separate reasons why PEK’s NAV has been elevated compared to TVIX and some of the other products.”

Premiums in PEK were expected since the fund provides exposure to China’s A shares market – access to the A share market has been strictly restricted by regulatory capital controls. The fund utilizes swaps and derivatives instruments to accomplish its stated objective. [Tom Lydon Explains ETF Premium and Discounts on CNBC’s Fast Money]

“PEK goes to a bank and enters a swap agreement, but because China’s A shares aren’t easily accessible, the bank has to charge a higher premium on the swaps to hedge its own risk,” Hempstead said. “That leads to the premium to NAV in PEK.”

However, China recently boosted its equity investment quotas for foreign investors. The investment quota for the QFII program has been raised by $50 billion to $80 billion early April, reports Andrew Galbraith for The Wall Street Journal. Policy makers are allowing more capital to enter the country since the economy experienced net outflows late last year.

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