ETFs: The “Through Train” has left the station

The Through Train has opened the doors to investors by relaxing the rules on buying Chinese shares


China’s investment landscape is changing. For years, investors around the globe have been restricted in which Chinese shares they could invest in. But on 17November, one of the biggest market liberalisation programmes began.

The Shanghai-Hong Kong Stock Connect programme, nicknamed the “Through Train”, relaxes rules which had prohibited foreign investors from buying certain Chinese shares. To deal with capital restrictions, many Chinese companies issued stock on multiple markets but foreign investors were restricted from buying some of the most profitable.

Historically, funds have bought unrestricted Chinese stock. These include H-Shares (listed in Hong Kong, like PetroChina), N-Chips (listed on the Nasdaq, like Baidu) and B-Shares, which are traded in international currencies on domestic Chinese markets. The MSCI China represents 160 of these companies and has quadrupled in the last decade.

But few could buy the better performing A-Shares. These shares are listed in Shanghai or Shenzhen and quoted in renminbi. Within the last decade, certain overseas investors have been permitted to purchase A-Shares through the QFII (qualified foreign institutional investors) license, but this has been subject to strict quotas. A-Shares are riskier, but investors have been rewarded.

This is a good time to invest into China. Chinese stocks are one of the cheapest markets globally and market reforms could open the door for further investment in the region. Profitability has been rising and cheap commodities markets will help this manufacturing heavy market. So how can UK investors access China?

Chinese ETFs

Exchange traded funds are one of the simplest ways to invest in Chinese equity. Few active fund managers have had success in China and it is an asset where more star managers have left than have emerged, like Jupiter’s Philip Ehrmann and the recently retired Anthony Bolton from Fidelity.

ETFs fall into three main categories. The traditional choice is those which hold a diversified index of unrestricted shares like the MSCI China index, which covers roughly 85 per cent of the market. The only ETF physically replicating this index is the HSBC MSCI China Ucits ETF (HMCH), which has an ongoing charge of 0.6 per cent per year. Source and db-X trackers also offer synthetic ETFs which have followed this index closely.

Another popular strategy is the large-cap Chinese ETF. These track a smaller index of unrestricted stock, like the FTSE China 50 Index. This index (which covered just 25 stocks until September) was considered a weathervane for Chinese equity performance and is representative of many of the most commonly owned companies. However its value for investors is in its liquidity – its concentrated portfolio of large shares should give it flexibility in times of stress.

The best known is iShares’ China Large Cap Ucits ETF (FXC) which has a total expense ratio of 0.74 per cent. Its US-listed sister fund is one of the largest Chinese ETFs, managing over $5bn.

The newest entrant is the A-Share ETF. Four ETF providers on the London Stock Exchange have partnered with Chinese investment managers, to access the required license to physically hold Chinese A-Shares.

Two of these ETFs have been very popular, the CSOP Source FTSE China A50 Ucits ETF (CHNP) with a TER of 1.11 per cent and the db x-trackers Harvest CSI300 Index Ucits ETF (RQFI) which charges 1.10 per cent. Both are currently at their asset limit and Deutsche Bank’s ETF stopped creating units in September, which has the potential to distort ETF performance. Lyxor and ETF Securities also run smaller products, but beware, bid-offer spreads can be high.

I believe that most investors should hold broad, diversified ETFs and it is a shame that none currently provide pan-Chinese exposure. In time this will change. Index providers are reviewing and A-Shares could be included in emerging market indices within two years years. Until then, investors wanting complete access will need to double up.

Key takeaway ETFs give access to all parts of the Chinese equity market though different products have very different objectives.