Update: db x-trackers CSI300 UCITS ETF

This ETF uses funded-swaps to synthetically track the index. Foreign investors investing in A-Shares are subject to QFII quotas and the swap counterparty, Deutsche Bank, being a QFII, has its own quota limit. Once the quota is reached, the swap counterparty may not be able to hedge its position, resulting in its inability to issue additional swaps and potentially disrupting the creation and redemption process. This could lead the fund’s market price to stray from its NAV. Investors should note that changes to the QFII/RQFII regulations in China may be made at any time by the Chinese government. One of the potential impacts includes narrowing of premium in the case of increase or abandonment of QFII quota, and vice versa.

Fundamentale Analyse

China achieved above-target growth in 2013. Gross domestic product growth clocked in at 7.7% in 2013, compared to a target of 7.5%. The economy appears to be set for another year of similar growth in 2014, and the government’s official growth target is again 7.5%, with the current run-rate (Q1-Q3 at 7.4%) roughly on pace to reach the target. The continual liberalising of the Renminbi and the interest rate regime along with the further opening of the country’s capital market should benefit China in the long run.

While economic growth in China should still rank it amongst the fastest growing economies in the world, investing in Chinese equities is not without risk. In March 2014, the Chinese corporate bond market experienced its first default. Interbank borrowing rates spiked on a number of occasions in 2013. These events have seized investors’ attention and have increased scrutiny of the health and stability of China’s banking system. In addition, in November 2014, the People’s Bank of China cut lending rates for the first time in two years.

The financial sector accounts for 40% of the portfolio, the largest sector exposure for the ETF, consisting mainly of Chinese banks (around 20%). Investors should be aware of any changes to the Chinese banking regulations and the effects it could have on incumbents’ market share. Ping An Insurance (4%), the largest component of this ETF, is the second largest insurance company in China by market capitalisation, after China Life Insurance. The performance of shares of Chinese insurance companies is also inherently linked to the China A-Share market itself as insurance companies invest their surplus in local equity markets.

The second largest sector exposure for this ETF is industrials, accounting for 15% of the portfolio, followed by consumer discretionary (11%), materials (8%), health care (6%) and consumer staples (6%). The industrials, consumer discretionary and consumer staples sectors are subject to export demand (e.g. for machinery and other exported consumer goods) and domestic growth, while the materials sectors are not only exposed to global materials prices but also to Chinese regulations and their overseas expansion strategies, if any.

The underlying stocks are listed on the Shanghai and Shenzhen Exchanges and quoted in Renminbi (RMB) while the funded-swaps are denominated in US dollars and the ETF is listed in Hong Kong and quoted in Hong Kong dollars. RMB has risen around 30% since it was de-pegged from the US dollar in 2005. The future course of the RMB remains in debate, especially as various countries’ easing programmes continue. Factors including, but not limited to, whether the US would label China as a currency manipulator and appreciation/depreciation of the US dollar against other major global currencies could affect the value of the RMB.

Indexkonstruktion

The CSI 300 Index is provided by the China Securities Index Company Limited (CSI), a joint venture between the Shanghai Stock Exchange and the Shenzhen Stock Exchange. It is one of the most widely quoted indices inside and outside Mainland China. The CSI 300 Index is a free float adjusted market capitalisation-weighted portfolio comprising the A shares of 300 large Chinese companies trading on the Shanghai Stock Exchange or the Shenzhen Stock Exchange. It is a price index, meaning it measures only price appreciation without taking into account dividends paid by the constituents. An advisory committee has certain subjective leeway in selecting the constituents. For inclusion in the index, stocks must have been listed for more than three months, must be in the most liquid 60% of all A shares, must not have had financial problems or legal/regulatory infractions, must not have exhibited large price volatility that shows evidence of manipulation, and must be considered appropriate by the committee. Once those screens are run, the 300 largest stocks are included. The underlying stocks are reviewed on a semi-annual basis and changes are made as needed. To control portfolio turnover, there are buffer zones around the index’s inclusion criteria, so that a constituent is not automatically removed if it fails to meet all the initial standards. Financials make up the largest sector of the index, representing around 40%, followed by Industrials (15%) and Consumer Discretionary (11%).

Fondskonstruktion

This ETF employs synthetic replication to track the underlying index by entering into a funded swap with counterparty Deutsche Bank AG. Investors’ cash is transferred to Deutsche Bank, which then puts collateral in a segregated account pledged to the ETF. As of end-November 2014, the collateral consists almost entirely of publicly-listed equities. The collateral is marked to market every day, and according to Deutsche Bank its total value at the time of writing was 122% of the ETF’s net asset value. Collateral is subject to certain margins and the amount is required to be 100% to 120% of the exposure. Collateral will be held by the custodian, State Street Bank Luxembourg S.A. Under the terms of the swap, the counterparty agrees to provide the ETF with exposure to the total return of the underlying index, net of any costs or fees associated with providing the exposure. The fund pays out dividends from the underlying exposure on an annual basis. The impact of dividends will likely cause the fund to consistently outperform its benchmark before fees, which is a price index. Dividend proceeds will be held by the fund until they are paid out. The ETF will not enter into stock lending transactions. The swap counterparty has its own QFII quota limit. Once the quota is reached, the swap counterparty may not be able to hedge its position, causing a disruption to the creation and redemption process. This could, in turn, result to the fund’s market price to stray from its NAV. Investors should be aware that this premium can change upon the change of regulation on QFII quotas and rules. In November 2014, the Ministry of Finance (MoF) and the China Securities Regulatory Commission (CSRC) put forth Notice 79 which asserted that QFIIs and RQFIIs without an establishment or place in China will be temporarily exempt from corporate income tax on gains derived from the trading of equity investments (i.e. capital gains tax; CGT) effective from 17 Nov 2014. The notice also stipulated that CGT will be imposed prior to 17 Nov 2014. However, there remain uncertainties, such as the calculation method, the means of collection, etc., which remain to be clarified, in our view. Subsequent to the Notice, the ETF’s provisioning policy was adjusted to only provide for CGT on realised gains prior to 17 Nov 2014. The tax exposures would be impacted if the tax rules are changed and/or further clarified.

Gebühren

The ETF levies a total expense ratio of 0.5%. Although this lies at the low end of the ETFs focused on Chinese equities. When investing ETFs, investors should take a holistic approach to assessing the total cost of ownership, also noting other costs including, but not limited to, swap fees, brokerage commissions, bid-offer spreads and tracking error. In particular, the ETF levies an “Index Replication Cost” of 2.65%. Tracking error for this ETF, measured on an annualised basis on a daily returns against the total return of the benchmark index, was 0.7% over the past year with a tracking difference of 4.9% for the same period (excluding the impact of the change in provisioning policy on CGT subsequent to the Notice 79).

Alternativen

There are a number of ETFs tracking the CSI 300 Index. Possible alternatives include the ChinaAMC CSI 300 Index ETF (listed in Hong Kong), C-Shares CSI 300 Index ETF (listed in HK), db X-trackers Harvest CSI300 Index UCITS ETF (DR) (listed in Europe), Deutsche X-Trackers Harvest CSI300 China A-Shares Fund (listed in the US), Horizons CSI 300 ETF (listed in Hong Kong), iShares CSI 300 A-Share Index ETF (listed in HK), Market Vectors ChinaAMC A-Share ETF (listed in the US), W.I.S.E. – CSI 300 China Tracker (listed in Hong Kong), W.I.S.E. KTAM CSI 300 China Tracker (listed in Thailand) and W.I.S.E. Polaris CSI 300 Securities Investment Trust Fund (listed in Taiwan). Amongst these ETFs, the ChinaAMC CSI 300 Index ETF, the C-Shares CSI 300 Index ETF, the db X-trackers Harvest CSI300 Index UCITS ETF (DR), the Deutsche X-Trackers Harvest CSI300 China A-Shares Fund, the Horizons CSI 300 ETF, and the Market Vectors ChinaAMC A-Share ETF, are physical ETFs, while the two ETFs listed in Thailand and Taiwan are feeder funds that invest in the Hong Kong listed W.I.S.E – CSI 300 China Tracker. The ChinaAMC ETF levies a TER of 0.85% and the C-Shares CSI 300 Index ETF levies a TER of 0.79%.

There are many other ETFs that track “Chinese” equities. Investors should note that these non-domestic China indices could have a low correlation with the domestic A-Shares indices, e.g. The CSI 300 Index (domestic) has a correlation of 97% with the FTSE A50 China Index (domestic) and 100% with MSCI China A Index (domestic), but only 55% to the MSCI China Index (non-domestic) during the past 3 years.