By Danielle Rutsky, DWS
If you quickly look at a list of exchange-traded fund (ETFs) that are focused on China, you may think their baskets all represent mainly the same exposure, but you would be mistaken. In light of the recent Easter holiday, you could compare choosing an investment to an Easter egg hunt. When you participate in an Easter egg hunt, you want to fill your basket as quickly as possible. However, you may end up with a vastly different basket of treats than the other participants, grabbing mostly raisins when you could have searched for the Kit Kats. You would not want to apply the same sort of haste to your investment process. Looking deeper into the various funds that invest in China reveals large inequalities between their baskets.
A Complex Market
Some disparities between China-focused funds are due to which share classes are included in their indexes. China’s various share classes make it a complex market and it can be hard to identify the differences. The term “Chinese equities” covers: A-Shares, H-shares, B-shares, N-shares, Red Chips, and P-chips, as seen in the chart below. Together, they make up the complete equities market for China. A-shares are by far the largest segment with over 3,500 listed equities and represent mainland China’s developing equity market. On a market-cap weighted basis, A-shares are almost 100 times the size of H-shares which comprise the second largest portion of China’s stock market. Yet, A-shares are not represented in many major indexes as they were previously restricted to only Chinese investors but have since greatly opened up to foreign investors. Hence, if an investor searches for China exposure the same way they hunt for Easter eggs, they could potentially buy a China fund that completely misses the largest portion of China’s stock market.
The components of the complete Chinese equities “basket”
|A- Shares||Renminbi (RMB)||Onshore||Stocks of companies incorporated in China and traded on the Shanghai and Shenzhen stock exchanges, A-Shares are the largest Chinese share class. Investors were originally domestic, but now include foreign investors through various programs.|
|B- Shares||U.S. dollar and Hong Kong dollar (USD and HKD)||Onshore||Companies incorporated in China and traded on the Shanghai|
(in U.S. dollars) and Shenzhen (in Hong Kong dollars) stock exchanges.
|H- Shares||Hong Kong dollar (HKD)||Offshore||H-shares are stocks of companies incorporated in China and traded on the Hong Kong stock exchange.|
|N- Shares||U.S. dollar (USD)||Offshore||N-Shares are stocks of companies incorporated in China but listed and traded on the New York Stock Exchange.|
|Red- Shares||Hong Kong dollar (HKD)||Offshore||Red Chips are stocks of Chinese companies (often state-owned or state controlled) incorporated outside of China and listed in Hong Kong.|
|P- Shares||Hong Kong dollar (HKD)||Offshore||P Chips are stocks of Chinese companies (often run by private sector Chinese individuals) incorporated outside China but listed in Hong Kong.|
Source: DWS Research
The Index Landscape
If you do a quick search for “China ETFs”, the first few funds that likely appear track indexes with very different exposure profiles. The CSI 300 Index is first to appear and includes the 300 largest and most liquid A-share stocks from the Shanghai and Shenzhen Stock Exchanges. The FTSE China 50 Index is listed next and contrastingly contains the top 50 companies that trade on the Hong Kong Stock Exchange and includes H-shares, Red Chips, and P Chips.
Even a list of the major ETFs focused on China’s broad economy will track indexes that give them baskets with varied exposures. The four most widely tracked indexes by ETFs listed outside China, with different methodologies for accessing the general Chinese market, include: the CSI 300, the FTSE China 50, the MSCI China A Inclusion, and the MSCI China All Shares Indexes. As seen below, only some of these indexes’ “baskets” contain A-shares that give direct exposure to China’s rapidly growing onshore market.
Source: MSCI Inc. and FTSE International Ltd. as of 12/31/18.
The overall most popular benchmark for exposure to China is the CSI 300 Index. As mentioned earlier, the index focuses solely on the A-share market. The most heavily tracked index for Hong Kong listed mainland companies and second most tracked index generally for China is the FTSE China 50 which, also noted earlier, does not contain A-shares. This index focuses on the approximate 250 H-shares or mainland China companies that are listed on the Hong Kong Stock Exchange. An investor holding only H-shares may want to add a specific A-share allocation to unlock the full benefits of diversification. Only 64 A-share companies are also listed as H-shares meaning an investor holding strictly H-shares is missing out on about 68% of China’s onshore equity market.
The Increasing Inclusion of A-shares
Another major index focusing specifically on A-shares is the MSCI China A Inclusion Index. The index tracks the ongoing inclusion of A-shares into the MSCI Emerging Markets Index. China’s significant reforms to its onshore market over the past couple of decades has allowed index provider MSCI to begin including A-shares as a part of their major global benchmarks as of May 2018. Mainly, regulators quadrupled the daily net buy limit of mainland securities for foreign investors through the Hong Kong Stock Connect in April 2018 and tightened stock suspension requirements, reducing the number of A-shares halted for trading by over 95% from a record high in 2015 to only about 20 by the end of 2018. These continued advancements mark another reason A-shares are an imperative part of China’s equity market and enabled MSCI to pick up the pace of the further 20% inclusion of A-shares which is scheduled to be implemented in May, August and November of 2019.
Before index providers fully include A-shares into their main global indexes, separate indexes represent the full China picture in regards to share classes. These indexes help investors navigate the complex Chinese stock market by providing proportional exposure to China’s share classes. The most commonly used index that captures China’s share classes on a market-weighted basis is the MSCI China All Shares Index which covers A-shares, H-shares, P chips, N-Shares, Red chips and B-shares. Due to the varying exposures of China-focused indexes, an investor looking to access complete China representation in one place may want to utilize this index.
Finding the Perfect “Basket”
China’s complex market can be hard to navigate as each share class makes up part of a comprehensive China “basket”. The country has become too big to ignore and investors and index providers are noticing as MSCI, FTSE, and S&P Dow Jones have announced increasing the inclusion of A-shares into their benchmarks. China is already the world’s second largest economy, and yet, China’s GDP will continue to grow at least 6% for the next three years, according to the IMF. This makes accessing A-shares as part of your allocation vital to fully capture the onshore portion of growth. Therefore, the composition of a China investment’s basket should be thoroughly analyzed as all investment “baskets”, just as Easter baskets, are not created equal.