China ETFs Are More Complex Than You Think

Investors with broad international equity exposure will include some China positions, but due to Beijing’s tight controls over its financial markets, foreign investors are underallocated to China’s domestic stocks. However, investors can now tap into the Chinese A-shares market through exchange traded funds.

As of September, 94% of the $10.3 billion in U.S.-listed China ETFs consist of Chinese company shares listed outside of mainland China – the China ETF components are listed on the Hong Kong Stock Exchange or on the New York Stock Exchange, according to a recent CSOP Asset Management research note.

ETF investors have gained access to China through H-shares ETFs – for instance, the iShares China Large-Cap ETF (NYSEArca: FXI) is the largest China ETF with $6.2 billion in assets under management. However, Hong Kong-listed Chinese companies only have a 0.65 correlation to mainland Shanghai Composite, or about the same as its correlation to the S&P 500 at 0.59.

Alternatively, due to its limited foreign access, China A-shares may offer greater diversification benefits for investors.

“Many portfolios are diversified across asset classes and market sectors, but relatively few equity classes show correlation benefits to US equities,” according to CSOP Asset Management. “Emerging markets, which includes China H listed shares currently, have been viewed as a good diversifier to US equity but correlations have been high relative to other classes due to strong correlation of China H shares to US markets.”

Chinese A-Shares are a specific class of equity securities issued by Chinese companies and denominated in RMB. Under current Chinese regulations, foreign investors may access A-Shares if they are a designated foreign institutional investor or gained access through either the Qualified Foreign Institutional Investor (QFII) or a Renminbi Qualified Foreign Institutional Investor (RQFII) programs.