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While we do not encourage investors to put all eggs in one basket, the strong growth of Chinese economy still magnetizes a lot of money from them. That shouldn't come as a surprise, since China equity funds have attained dazzling records in the past three years, and the fervor only started to subside until China's implementation of macroeconomic tightening measures early this year. Indeed, these government measures aim primarily to sustain the Dragon's stable, long-term growth. Moreover, the sudden increase of interest rate in late October, the pledge for more flexible currency practices, as well as the approval of more QDIIs and QFIIs, all points to the progress towards a more matured and open China financial market. To investors, the good news is not only the rewards from their stock investments, but also more cheaper ways to tap this market – index funds. Last year, Hang Seng Investment has launched the China Index Fund and H-Share Index Fund Series. After launching the iShares MSCI China Tracker in 2001, Barclays Global Investors (BGI) is adding iShares FTSE/Xinhua A50 China Tracker on November 18 to its exchange traded fund series this year. This ETF tracks an index of 50 large China companies in the A-share market. Instead of investing directly into A-share stocks and unlike traditional fund managers whom invest through equity-linked securities, this fund uses an option security called Chinese A Share Access Product (CAAP) that linked to an A share. As each CAAP is linked to only one stock, it allows fund manager Hing S. Tang to replicate and rebalance the index portfolio. In fact, Tang explains that the choice of CAAPs has taken into account of their cheaper costs than ELIs while having 100% participation rate in the stock's performance.
According to the studies by BGI, the correlations between the A50 index and the Hang Seng Index, Hang Seng China Enterprises Index and MSCI China Index range from 0.13 to 0.2 over the past 12 months, meaning the index barely moves in sync with Hong Kong large-caps, red chips and H-shares. On the other hand, the correlation is much higher between the index, Shanghai Composite Index and Shenzhen Composite Index (0.95 and 0.86). Since most of the China funds invest quite a portion of their assets in China plays, or Hong Kong companies with substantial business exposure to China, the low correlation with the Hong Kong-listed China stocks means this ETF can serve as a risk diversifier for Chinese investments. Besides, the CAAPs are denominated in US dollar. In case yuan appreciates against the dollar, the currency gains will be reflected on the CAAP prices. That said, since the fund is quoted in Hong Kong dollar, a change in the HKD/USD rate can offset some of the currency gains. Stock overlaps with other funds may also happen, as some of the stocks in this index have been concurrently listing in either the B-share or H-share market. In all, this ETF offers a means for investors who are neither Chinese citizens nor QFIIs to invest in the China A-share market. Although its annual management fee at 0.99% is not very cheap, it is still lower than the 1.36% charged by an average China Equity fund.
Even so, the inflexibility in portfolio makeup curbs performance surprises from index funds, unless the respective markets take off. On the other hand, managers of actively managed funds are less restrained by the benchmark in their portfolio construction and could enhance returns through skillful stock picking. There are actually a few fund choices which can also invest in A-shares, but investors should note that their levels of maximum exposure vary. More important, these China-focused funds are all subject to China policy risks, regardless of their portfolio building approaches. Table 1. A Comparison of Different Types of Funds with China Investment Focus
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