Getting In On China’s ‘A’ Game

This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

With roughly 30 established China ETFs to choose from, it may seem that every angle for exposure to the world’s second largest economy has been explored, if not exhausted.

Despite the profusion of exchange-traded funds, a new one is coming that specializes in locally-listed Chinese stocks, something that could give investors an attractive alternative to what’s available now.

The venerable iShares FTSE China 25 Index Fund (FXI), the most heavily traded China ETF and the one with the largest assets (nearly $7 billion), is down 14.8% year-to-date. The big state-owned companies in the FXI are big laggards this year compared to the small stocks traded as “A shares” on the Shanghai Composite, which is down a far less severe 4.9% so far this year.

A-Shares are those issued by companies incorporated in mainland China and are traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange. These stocks are available only to domestic Chinese investors and certain approved qualified foreign institutional investors. Foreign investors are generally prohibited from buying A-Shares and thus the bulk of China ETFs are invested in H-Shares, so called because they are a separate class of stock trading on the Hong Kong Stock Exchange. China ETFs may also invest via US ADRs, illiquid B-Shares and P-chip companies listed outside mainland China and controlled by private Chinese shareholders.

Simply put, not holding A shares puts investors into a separate class and exposes them to a variety of hazards including subordinate dividend rights, excessive currency fluctuations, and in some instances, inferior stock performance. So far, the only way to tap into the A share market via ETFs is with the Market Vectors China ETF (PEK) that tracks the CSI 300 Index. That’s about to change with the introduction of two new ETFs from KraneShares that invest in China’s local stock market.

These ETFs will allow overseas investors to tap into companies like China Merchants Bank (HKG:3968), the first Chinese bank that is not state-owned. I met with Dr. Weihua Ma, CEO and president of the bank, in Monaco at the Ernst & Young World Entrepreneur of the Year Awards. CMB under Ma’s leadership has grown from 30 employees in 1999 to over 50,000 employees, with 900 branches and assets approaching $500 billion at the end of 2012.

Addressing this success, through a translator, Dr. Ma said, “China Merchants Bank has always had a Western mentality to doing business, and uses government resources in a limited manner and only when they can really be leveraged to help growth.”

One concept that is decidedly Western is the idea of a level playing field which came up as we parsed the differences between shares of Chinese companies owned by a typical China ETF versus those KraneShares plans to buy for its funds, CSI 300 China A Share and MSCI China A Share.

Although based in the New York, KraneShares has an office in Beijing. Plus, according to its filing, its indexing firm CSI is a China-based company. These boots-on-the-ground are critical as the company aims to invest in the A-shares of Chinese companies, specifically those which will benefit from the country’s twelfth five-year plan. KraneShares is hoping to launch as early as next month.

China, for all its faults, sticks closely to its stated five-year plans, the most recent of which was published by the National People’s Congress in 2011. Famed China bull investor and Quantum Fund co-founder Jim Rogers has been vocal about studying these plans saying, “Whatever the government decides it wants to do, it will probably make a lot of people rich in those sectors.”

KraneShares strategy distills therefore into identifying those companies which will benefit from government support as the five-year plan rolls out and investing in their respective A-Shares. For example, one notable five-year plan is reducing energy consumption and the government has already announced a $449 billion investment into a high-speed rail network expansion.

Obviously institutional investors can do their own due diligence and invest directly. Indeed, U.S. corporate investors put over $1 billion into China in the first quarter of this year, up 18.5% from the same period last year, according to the Ministry of Commerce.

However, for investors exploring China ETFs, their due diligence might include reading the fine print of a fund’s prospectus and seeing what its strategy is for investing in A-Shares.

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