A-share ETF fever amps up

When it comes to China ETFs, there is no clear winner on all fronts. Performance, headline fees and trading costs vary dramatically. But the range of choice gives you some solid options. In 2014, the Stock Connect launch prompted a flurry of ETF launches, giving investors a range of index options to track. Popularity and increased competition has also led to a drive down in prices. Last month Deutsche Bank cut the price of its db x-trackers Harvest CSI300 Index UCISt SETF (DR) (RQFI) at the same time as iShares launched its first iShares A shares product, chopping its ETF fee from 1.1 per cent down to 0.65 per cent to match iShares MSCI China A UCITs ETF (IASH).

The indices have returned markedly different returns and the trading costs of some ETFs, along with tracking differences have meant that the returns have been varied. Of all the indices, the MSCI China A index has performed the best in the year to date, returning 58.72 per cent. However China is a volatile market, and in 2013 it fell by 1.12 per cent and then returned less than other indices in 2014. The benchmark gives the broadest exposure, with over 500 constituents, compared to the popular CSI300 index, which offers exposure to 300 A-Share stocks listed on the Shenzen or Shanghai Stock Exchange.

Lyxor Fortune SG UCITs ETF MSCI China A (CNAL) tracks the MSCI China A and has delivered the best returns in the year to date. However, it is one of the most expensive, with an ongoing charge of 0.95 per cent.

However price and tracking are not the only considerations when looking at China ETFs. Due to the relative youth of some of the key indices and the fact that China A shares remain relatively illiquid, the cost of trading these ETFs can be high and will take its toll on your returns.

Adam Laird, head of passives at Hargreaves Lansdown, says: "Recently physical A shares ETFs spreads (the difference between the buy and sell price of a fund) have been at around 1-1.5 per cent versus 0.3-0.5 per cent for some of the H shares (mainland China shares trading on the Hong Kong exchange). That compares to around 0.05 for the FTSE 100."

It means that the physically replicating ETFS, which actually hold A shares, carry higher trading costs than their synthetic counterparts. So funds like ETFS-E Fund MSCI China A GO UCITS ETF (CASE) currently have a five-day bid-ask spread of 2.09 per cent compared with 0.88 per cent for the synthetically replicating db X-trackers CSI300 Index ETF (XCHA). In part this is due to the fact that some of the most appealing products are fairly new and so less liquid. That helps explain the wide spread on new iShares MSCI China A UCITS ETF (IASH). Ben Seager Scott, ‎director of investment strategy at Tilney Bestinvest says he prefers physically replicating products.

However, both the new iShares product and the physically replicating db X-trackers Harvest CSI300 INDEX UCITS ETF (RQFI) have the benefit of the lowest ongoing charges.

In the short term views are mixed as to whether or not the MSCI decision to include A shares in the emerging market index would send A shares on a rally. Mr Seager-Scott says: "The indexation effect has been talked about for ages and a lot of money has already flowed in on that argument. I wouldn't make a deicion based on the indexation event."

Over the longer term, the key to the Chinese market will lie in the actions of the Central Bank. In recent months investors have been piling into Chinese equities, making the most of recent rate cuts and market liberalisation. With a slowdown in domestic growth troubling policymakers, the country is widely thought to be on the verge of turning to quantitative easing, a move which would further boost the market.

There is also no doubt that A shares will be increasingly prevalent in emerging markets funds. Last year FTSE launched an alternative index to its mainstream emerging markets benchmark which includes A shares. And last week Vanguard announced it had chosen to add Chinese stocks to its flagship emerging market fund for the first time, in a move which will give Shanghai and Shenzhen-listed stocks a 5.6 per cent weighting.

ETF and index description

Source: Hargeaves Lansdown, Morningstar

Calendar year total return (%) of ETFs and benchmarks tracked

Source: Trustnet, as at 3 June 2015

Bid-offer spread of ETFs

Source: Hargreaves Lansdown, 3 June 2015.