When choosing a single-country exchange traded fund (ETF) you generally assume you will be given exposure to one of the markets in that country. However, with China ETFs the situation is slightly different, so paying attention to which index your ETF tracks is very important. Although an ETF's name may suggest it tracks a China index, it may track Hong Kong shares.
To access shares listed in China and quoted in Renminbi your ETF needs to track 'A' Shares. These are available to foreign institutional investors who have a licence to buy them. Examples of indices that include 'A' shares are CSI300 and FTSE China A50. The FTSE China 25 and HSCEI include 'H' Shares in Hong Kong.
The mainland 'A' share index is more diversified, with 300 shares as opposed to 40 on the HSCEI and 25 on the FTSE China 25, and its top three sectors account for 65.49 per cent of the index as opposed to the HSCEI's top three, which account for 90.13 per cent, and FTSE China's top three, which account for 87.3 per cent. Due to differences between the mainland and Hong Kong stock markets - environment, investors and inconvertibility between 'A' shares and 'H' shares - their prices can diverge.
ETF provider db X-trackers, which offers ETFs exposed to both China and Hong Kong shares, says that China 'A' shares provide access to a restricted market and more comprehensive exposure to China.
However, a concern for foreign investors in 'A' shares is the possibility of the Chinese government exacting capital gains tax. The details of the tax are not clear, but db X-trackers estimates that if it is levied it could have a 0.03 per cent detriment to net asset value (NAV).
Also, due to the restricted access for foreign investors to Chinese 'A' shares there is a difference between the ETF trading price and the NAV level - a premium or discount - mainly driven by factors such as market demand and supply on China 'A' shares ETFs. More mainstream ETFs generally don't experience problems with discounts and premiums to NAV, unlike investment trusts.
Hong Kong shares are easier to buy and sell.
So which ETF should you go for?
"In broad terms the most representative index is the CSI 300, but this is also the most expensive and probably the most illiquid in a crisis," says Peter Sleep, senior portfolio manager at Seven Investment Management. "The MSCI and China Enterprise indices are somewhere in between. The FTSE 25 index is only 25 stocks from the Hong Kong market so it is not too representative, but it is somewhat cheaper to trade and more liquid. The Hong Kong focused indices are all heavily weighted in financials and basic materials, but they are cheaper and more liquid. If I was trading in and out for periods of up to a year, I think I would buy either the HSBC MSCI China ETF (ISIN: IE00B44T3H88) or Lyxor ETF China Enterprise (HSCEI) (ISIN: FR0010499749) which are relatively well diversified. But for the longer term it might be an idea to take a look at an active manager such as Anthony Bolton, who runs the Fidelity China Special Situations investment trust which is trading at a discount and has access to all the research of a team of analysts."
HSBC MSCI China ETF buys the shares it invests in and has a total expense ratio (TER) of 0.6 per cent, while Lyxor's fund gets its return via a swap and has a 0.65 per cent TER.
MSCI China includes companies incorporated in the People's Republic of China and listed in US dollars in the form of 'B' shares on the Shanghai Stock Exchange or in Hong Kong dollars on Shenzhen Stock Exchange. It also includes 'H' shares on the Hong Kong Stock Exchange.
Meanwhile, iShares offers its FTSE China 25 ETF (ISIN: IE00B02KXK85) which buys the physical shares rather than using a swap to replicate index performance. "I would argue, given that it is only 25 shares, that this is expensively priced at 0.74 per cent, but it is cheap to trade, with a bid-offer spread of less than 0.2 per cent when you buy and sell the ETF," says Mr Sleep.
If you want exposure to mainland China, then db X-trackers has recently launched the CSI300 Index ETF (ISIN:LU0779800910), which has an all-in fee of 0.5 per cent and uses a swap to get its returns.
