New China ETF dodges overvalued stocks

Index provider FTSE Russell launched the FTSE China A-H 50 Index last month, which is now tracked by db x-trackers Harvest FTSE China A-H 50 Index UCITS ETF (AH50). These are the first index and ETF to overcome a confusing anomaly in Chinese equity trading, which results in identical stocks trading on the domestic and offshore market at wildly different prices. The Chinese equity market is a confusing mix of share types due to the distinction between the expensive, highly restricted and volatile domestic A share market, and the same stocks' listings on offshore markets such as the Hong Kong exchange, where they are known as H shares.

A shares are renminbi-quoted stocks listed on the Shanghai and Shenzhen stock markets, and foreign investment limits means that few people can gain access to them. It is a market dominated by private investors, making it subject to dramatic swings, and stocks on it trade at a premium to the same ones listed elsewhere.

Some of the main China index choices until now have been:

■ FTSE China A50 Index, the 50 largest A share companies;

■ FTSE China 50 index, the 50 largest and most liquid H share, Red chips and P chips - Chinese companies incorporated and traded outside of mainland China;

■ CSI 300 Index - a broader A share index tracking 300 companies from the Shanghai and Shenzhen exchanges; and

■ MSCI China Index - 157 stocks covering 85 per cent of the China equity universe across China H shares, B shares, Red Chips and P Chips

The A share market boomed in popularity following the announcement of the Shanghai-Hong Kong Stock Connect programme in April 2014, enabling investors on each exchange to trade in the other. Between April 2014 and June 2015 the CSI 300 index soared by 179.3 per cent. But the Chinese bubble burst dramatically in August 2015 and the CSI 300 Index fell 44.5 per cent between June 2015 and the end of August.

Despite that, on a three-year basis the FTSE China A50 Index has returned more than the H share index by far. The FTSE China 50 is down 15.1 per cent over five years, according to FTSE, compared with a positive return of 7.3 per cent from A shares.

The new FTSE China A-H 50 Index claims to offer exposure to the best of both worlds - top-performing A shares and cheaper versions of the most expensive stocks if they are also listed in Hong Kong. It starts with the top 50 A share companies traded in Shanghai and Shenzhen and for the 28 stocks that are dual listed, buys the H shares if they are cheaper. The exception is Shenzhen stocks, which are selected whether or not they have an H share counterpart. FTSE claims that returns from this index are likely to be better than either the H or A share index alone because inflated prices are stripped out.

According to back-tested data generated by the index provider, the FTSE China A-H 50 has outperformed both the other indices, returning 12.7 per cent over five years.

However, for investors in China, the price of stocks is just one concern. The Chinese market has been a volatile place to be invested in over the past year, with the country's Black Monday market rout in August 2015 leading to a global crash. Diversification and stock selection are key to ETF selection, and the new index throws up some problems when it comes to concentration.

According to Deutsche Asset Management, db x-trackers Harvest FTSE China A-H 50 Index UCITS ETF is 72.8 per cent allocated to financials. With just around 50 stocks that makes it a very concentrated fund, particularly compared with an ETF such as db x-trackers Harvest CSI300 Index UCITS ETF (RQFI), which has around 300 stocks and just 35.6 per cent in financials.

FTSE groups its sectors differently, splitting out insurance and real estate but banks still make up a very large concentration of the A-H 50 Index - more than either the FTSE China 50 or the FTSE China A50. As well as accounting for 40.8 per cent of the fund in total, they also account for four out of the top five companies in the index. The top five companies in the A-H 50 Index, which also include life assurance company Ping An insurance, account for 32 per cent of the index.

Adam Laird, passive investment manager at Hargreaves Lansdown, says a broader index is a better option in a high-risk market such as China. With the A-H 50 Index "you're maybe gaining diversification in the market you trade on, but you are losing diversification in terms of sector and number of holdings. I think that because of its breadth, the CSI 300 Index is probably one of the most appealing to me."

Mr Laird also highlights the MSCI China A and MSCI China indices. MSCI China A Index has over 800 constituents focused on the Shanghai and Shenzhen stock exchanges, and MSCI China Index, which has has 157 constituents, includes China H shares, B Shares, Red chips and P chips.

Mr Laird acknowledges that there are benefits to arbitraging the price difference between the A and H share market, but says his ideal China product would "have holdings from all of the markets out there. China is many markets: it's A shares, H shares, companies with a primary listing in Hong-Kong and American Depositary Receipts (Chinese companies listed in the US). There is not really a product out there at this moment which gives a broad exposure to all of those."

And he adds: "The volatility you get with Chinese equities means you need to seriously think about where to invest, and with an index I think broad and representative is best."

FTSE China indices performance (annual total return %)

Source: FTSE

db x-trackers Harvest FTSE China A-H 50 Index UCITS ETF (AH50) top 10 holdings

Source: Deutsche Bank Asset Management, as at 22.03.16

A-H 50 index sector weightings

Source: Deutsche Bank Asset Management, as at 22.03.16

CSI300 index sector weighting

Source: Deutsche Bank, as at 29.02.16

Performance (% cumulative total return) China offshore equity ETFs

Source: FE Analytics, as at 4.04.16

Performance (% cumulative total return) China onshore equity ETFs

Source: FE Analytics, as at 4.04.16