New deal could build competition among China-stock ETFs

As financial advisers scour the globe generally and emerging markets specifically for new investment opportunities, they could be finding new opportunities in China. On Wednesday, Van Eck Associates struck a deal with a Hong Kong investment firm that allows its $28 million Market Vectors ChinaAMC A-Share ETF (PEK) to invest directly in stocks traded on Chinese exchanges. It's only the second ETF to gain direct access to the A-share class of Chinese stocks. Such stocks, which have been restricted from investment by investors from outside the country, represent two-thirds of the companies in China. The deal, and the newly restructured fund, could put pressure on Deutsche Bank's db X-trackers Harvest CSI 300 China A-Shares Fund (ASHR), which was the first to enter the market. Specifically, the Market Vectors ETF undercuts ASHR's 1.08% expense ratio by 0.36%. The ETF will follow a passive investment strategy that tracks the CSI 300, an index of the 300 largest companies traded on the Shanghai and Shenzhen stock exchanges. Prior to the January agreement, the Market Vectors ETF replicated returns on the CSI 300 using derivatives. A number of other ETFs continue to use derivatives to mimic exposure to Chinese stocks, including PowerShares' China A-Share Portfolio. According to Amrita Bagaria, an ETF product manager with Market Vectors, the main advantage of purchasing Chinese A shares directly is reduced counterparty risk. “When you enter into a swap or derivative agreement, you enter into a third-party agreement with a bank,” she said. “The agreement is in good faith, but there is always a risk that the bank won't be able to pay. Purchasing the shares directly cuts out the middleman.” So far, ETFs that track the CSI 300 have not been sterling performers. The Deutsche Bank ETF is down 8.69% since its Nov. 6 inception through Tuesday, and the original Market Vectors fund is off almost 16.63% over the 12-month period ended Tuesday, according to Bloomberg. Over that same 12 months, the CSI 300 fell 9.82%. Nonetheless, these funds have seen some growth, with assets in the Deutsche Bank fund climbing to $214 million from $108 million when it launched. Some companies in the CSI 300 are traded on exchanges other than Shanghai and Shenzhen and are easily accessible to international investors. But others can only be accessed through China's exchanges. In addition, only a limited number of foreign investment firms are allowed to purchase shares on these exchanges, and the number of shares is capped by a quota. One of the qualified firms, China Asset Management, is the one with which Van Eck is dealing. “A lot of investors who say 'I own China' don't really own China,” said Ms. Bagaria. “They are missing the two thirds of the equity market that are A shares.” Some of the companies that are only accessible through A shares include China's largest automaker, SAIC Motor, and its largest producer of fertilizer, Quinghai Salt Lake Industry, Ms. Bagaria said. One potential drawback is that many of the largest companies in the CSI 300 are state owned and expected to play a diminished role as China institutes economic reforms, said Patricia Oey, a senior fund analyst at Morningstar Inc.