Update: Harvest MSCI China A Index ETF

This ETF employs physical replication by utilising the RQFII quota obtained by the manager and through the Shanghai-Hong Kong Stock Connect to invest directly in the A-Share market. With any quota system, supply/demand dynamics could be distorted, in particular, once the quota is reached, the manager may not be able to acquire additional RQFII quota, forcing the manager to suspend creation of units. These quota-related considerations together with other factors such as trading limits which apply to the underlying stocks, could lead the ETF’s market price to stray from its NAV. It is worth noting that there is a clause in the fund’s prospectus which stipulates that the ETF could be terminated if its aggregate net asset value falls below Rmb 180 million. As of 24 December 2015, the ETF had assets under management of Rmb 241 million.

Investors should note that changes to the QFII and RQFII regulations in China may be made at any time by the Chinese government. One of the potential impacts includes a possible narrowing of the ETF’s premium to its NAV in the case of an increase to or abandonment of the RQFII quota, and vice versa.

Fundamentale Analyse

China’s GDP grew at 6.9% in the third quarter of 2015. This was the first time since 2009 that the nation’s GDP growth fell below 7%. Also, this is lower than the 7% growth registered in both Q1 and Q2, and the 7.4% expansion registered in 2014. Note that the government’s full year GDP growth target was set at “around 7%”.

While high-single digit economic growth should still rank China amongst the fastest growing economies in the world, investing in Chinese equities is not without risk.  The Chinese stock market’s plunge in June and July 2015 has led to increased government intervention. Investors should take a step back and assess how these actions might impact the market. This is especially relevant from a fundamental (i.e. risk/return) and regulatory standpoint.

In the past year, the People’s Bank of China (PBoC) has become more aggressive with its monetary easing. It reduced the reserve requirement ratio (RRR) on a broad-base in October, August, April and February 2015 and cut rates in October, August, June, May, and February of 2015 as well as in November 2014. In the long run, China should benefit from the ongoing liberalisation of the Renminbi and its interest rate regime, as well as further opening of its capital market.

As of November 2015, the financial sector accounts for 29% 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 (3%), the largest component of this ETF, is the second largest insurance company in China by total 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 industrial, accounting for 20% of the portfolio, followed by consumer discretionary at 11% and materials at 9%. 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 sector is not only exposed to global energy prices but also to Chinese regulations.

Indexkonstruktion

The MSCI China A Index is a free float adjusted market capitalisation-weighted index representing 10 sectors across the China domestic A-Share market with 584 constituent stocks as of this writing. The index aims to capture approximately 85% of the free float market capitalisation of the investible domestic Chinese equity universe. It is a price index, meaning it measures only price appreciation without taking into account dividends paid by the constituents. Component stocks have to fulfill MSCI’s size, liquidity, free float criteria and length of trading to be included in the index. The index is reviewed on a semi-annual basis with minor quarterly reviews to accurately reflect the evolving marketplace. As of 30 November 2015, Financials make up the largest sector of the index, representing 33%, followed by Industrials (20%) and Consumer Discretionary (11%).

Fondskonstruktion

This ETF intends to use full physical replication to track the performance of the index. This ETF employs physical replication by utilising the RQFII quota obtained by the manager to invest directly in the A-Share market. Once the quota is reached, the manager may not be able to acquire additional RQFII quota, forcing the manager to suspend creation of units. These quota-related considerations together with other factors such as market supply/demand dynamics and trading limits which apply to the underlying stocks, could lead the ETF’s market price to stray from its NAV. The ETF also utilises the Shanghai-Hong Kong Stock Connect to invest into the A-Share market. In June 2014, the State Administration of Foreign Exchange (SAFE) changed RQFII quota policy to allow RQFII holders to allocate their RQFII quota granted across different public fund products under their management and hence there is no longer a specific quota granted to specific products. There is no intention for the ETF to engage in securities lending. There is no intention for the ETF to engage in securities lending. This ETF offers RMB counter (83118) and Hong Kong dollar (HKD) counter (03118) for trading on the Stock Exchange of Hong Kong. Units traded on both counters are of the same class and all unit holders of both counters are treated equally. Investors can buy units in one counter and sell units in the other counter, provided their broker supports this service. However, creation and redemption are carried out only in RMB, while newly issued units from creation in the primary market can be designated in the RMB counter and/or HKD counter immediately upon issuance. The base currency of the ETF is in RMB. As a result, market price of the HKD counter is also subject to RMB exchange rate fluctuations. Distributions are made annually (usually in October) where both counters will receive distributions in RMB. 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 capital gains tax (CGT) effective from 17 Nov 2014. The notice also stipulated that CGT will be imposed prior to 17 Nov 2014. Subsequent to the Notice, the ETF’s provisioning policy was adjusted to only provide for CGT on realised gains prior to 17 Nov 2014. On 6 Nov 2015, the manager of the ETF announced that it obtained an HK Tax Resident Certificate for the year ended 31 Dec 2014 and that it had made a reversal on a provision for CGT amounting to +8.82% of the ETF’s NAV after the Shanghai tax authority’s agreement on the tax treaty application.

Gebühren

The ongoing charges based on expenses for the financial year ended 31 December 2014 was 0.89%. This lies at the middle of the range of ETFs focused on Chinese equities and at the low-end of the RQFII ETFs. In the past year, tracking error for this ETF, measured on an annualised basis on daily returns was 1.67% (excluding the change in NAV on CGT provisioning adjustment). This is at the high-end when comparing to the other RQFII ETFs and compares to a range of 0.5%-2% for synthetic A-Share ETFs listed in Hong Kong. This ETF had a tracking difference against the total return index of positive 0.2% (excluding the change in NAV on CGT provisioning adjustment, where its NAV as of 6 November 2015 was increased by 8.82% due to the change) during the same period.

Alternativen

This is the only ETF in the market tracking the MSCI China A Index. There are a number of ETFs offering China A-Share exposure, albeit through different underlying indices, e.g. the FTSE China A50 Index, the MSCI China A 50 Index, the CSI 100 Index and the CSI 300 Index.

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 MSCI China A Index (domestic) has a correlation of 91% with the FTSE China A50 Index (domestic), 93% with the CSI 100 Index and 98% with the CSI 300 Index (domestic), but only 73% to the MSCI China Index (non-domestic) during the past 3 year.