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Accessing China via ETF Connect: Why now, and how

With China’s recent reopening re-igniting global investor appetite for domestic equities, China Asset Management Co Ltd (ChinaAMC) believes thematic exchange-traded funds (ETFs) offer an effective route to resilient returns.
Accessing China via ETF Connect: Why now, and how

China-themed ETF are seeing strong demand from global investors who are betting on the country’s shift away from Covid Zero. As investors pile in money amid the rebound in economic activities, monetary policy easing and cheap valuations, November marked the best monthly rally in Hong Kong-listed Chinese stocks since 2003.

The question now is, can the rally continue? Bulge bracket investment banks are sanguine. Morgan Stanley lifted Chinese equities to overweight from the equal-weighting position it had held since January 2021. Goldman Sachs has predicted that Chinese stocks will outperform in 2023, while Bank of America has turned tactically positive.

For investors who do not want to miss the opportunities, they are now weighing various options for their China exposure.

In particular, after the July 2022 launch of a new programme called “ETF Connect”, global investors have direct access to the vibrant onshore market with a basket of stocks, via the ETF wrapper. That’s in addition to the traditional route of buying overseas-listed stocks or ETFs.

Another consideration for international investors is, should they buy onshore ETFs given they can also directly access individual stocks in the mainland market? Further, if they see ETFs as a better option, should they continue to buy China-focused ETFs listed in Hong Kong and New York, or give onshore ETFs a chance? And what should these investors buy from the menu of as many as 83 ETFs, which is the initial approved batch?

To answer these questions, investors should first explore China’s idiosyncratic ETF market.

China’s burgeoning ETF scene

China’s ETF market is in the midst of a growth spurt, driven by higher market efficiency, lower fees and higher transparency. Demand for ETFs has therefore increased significantly, and there is a growing variety of ETFs available to meet the differing needs of investors.

This follows impressive growth since 2018, with ETF AUM jumping seven-fold from RMB208.8 billion ($30.0 billion) at the end of 2017 to RMB1.48 trillion by the end of June 2022 (data source: Wind. Same below). Equity ETFs (including cross-border products) make up the largest market share, with 640 ETFs contributing a total AUM of RMB 1.1 trillion, representing 91.6% of products and 74.2% of AUM across the board.


Source: Wind, data as of 12 December 2022

Despite their growth, equity ETFs still only account for 2.43% of the free-float market cap of the A-share market. That compares with the 8.9% share in the US, implying there is still notable room for growth.

Unlike markets elsewhere, where broad-based ETFs represent the majority of the market, sector and thematic ETFs in China have overtaken their broad-based peers, both in terms of product number and AUM, though the average AUM is smaller than broad-based ETFs. 


Source: Wind, data as of 12 December 2022

The thriving sector and thematic ETFs, a feature of China’s onshore ETF market, are closely correlated with the activism of retail investors. Compared with institutional investors, retail buyers tend to trade sector or thematic ETFs based on their preference for corresponding industries and themes. As a result, such ETFs are held predominantly by retail investors (74.15% as of end-2021, compared with 56.66% for broad-based ETFs).


Source: Wind, data as of 12 December 2022

More vigor, more choice

Offshore investors can derive two clear benefits from the greater participation of Chinese retail investors. Firstly, retail investors trade frequently; the average daily trading volume of equity ETFs soared from RMB4.58 billion in 2014 to RMB36.87 billion (the second quarter of 2021). This means there is greater liquidity, which is amplified by brokers employed by ETF issuers. The windfall is lower tracking error, an important consideration for institutional investors.

Secondly, there are a greater volume of sector or thematic ETFs on offer, some of which are quite niche, in turn providing a wider range of options for offshore investors. Products such as food & beverage ETFs and new energy vehicle ETFs, for example, are simply not available overseas.

Research also shows a tilt by northbound investors towards such ETFs, as they offer exposure to stocks that are not typically on northbound investors’ lists. Analysis from ICCC, an investment bank, shows the top five stocks held by the 58 sector or thematic ETFs that can be accessed offshore are complementary to northbound investors’ favorite picks, with only one overlap.

There are further imperatives for offshore investors to opt for onshore ETFs over individual stocks or overseas-listed China ETFs. Some offshore investors may lack the resources to conduct adequate research on over 4,700 listed companies in the A-share market.

In addition, ETF products have a transparent risk-return profile, which is important for offshore investors who are less familiar with the Chinese market. ETFs are also exempt from stamp duty (not for stock trading).

Products matter, managers matter also

Given there are ETF products from about 20 Chinese asset managers in the northbound trading list, the profile of specific products should be the top consideration for investors. However, they should also weigh brand names of the managers behind certain ETFs, especially when it comes to ETFs tracking the same or similar indexes.

Notably, since size and liquidity matter, it is important for investors to be aware that ChinaAMC has been the biggest player in China’s equity ETF market in terms of AUM for 17 years running, since the debut of the country’s first ETF product, ChinaAMC SSE 50 ETF, on the final day of 2004.

Experience also counts. ChinaAMC has accumulated an extensive investment track record over the past 17 years and is well recognised among domestic and international institutional investors. ChinaAMC has been awarded the "Golden Bull Fund Company for Passive Investment" by China Securities Journal for six consecutive years (2015-2020) and named the Best ETF Manager in China by Asia Asset Management for five years running (2018-2022).

Although for now northbound inflows into onshore ETFs remain tiny compared with that of Stock Connect, Goldman Sachs research analysts forecast that over the next decade the programme could funnel as much as $130 billion into ETFs listed in mainland China, and $50 billion into ETFs listed in Hong Kong, if more products are added in the coming years.

"One of the things the ETF Connect can do is boost international investors’ understanding of mainland China ETFs and increase the products’ influence," said Xu Meng, executive director of ChinaAMC’s Quantitative Investment department. "We should play the long game."

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