While you can argue about whether China’s long-term economic picture is setting itself up for a stumble or not, the next 10-15 years should be pretty rosy for the Chinese economy. It’s still experiencing enviable GDP growth, rising industrial gains, expanding infrastructure and an expanding middle class which loves to shop — all hallmarks of a great emerging market investment.
And many investors have seized that potential by adding funds like the $5.8 billion iShares China Large-Cap (FXI) or individual Chinese equities such as Baidu (BIDU) to their portfolios.
That’s all well and good, except by going with these conventional methods, investors are leaving the bulk of China on the table — to the tune of $4 trillion in market cap. That’s because, the majority of China’s equity market has been off-limits to international investors since the 1980s.
The new db X-trackers Harvest China ETF (ASHR) allows investors to bet directly on the A-shares listed on China’s Shanghai and Shenzhen stock exchanges. That’s an unprecedented feat for a U.S.-listed fund and could be the best way to ultimately play China’s continued growth.
Chinese Shares In A Nut Shell
For many investors looking towards international investing, the process is pretty straightforward. For example, French companies are traded on the Euronext Paris or — like energy firm Total (TOT) — trade as ADRs in North America. It’s pretty easy to gain access to both share classes, either through funds or directly. At this point, anyone with a brokerage account can access France’s stock markets with ease.
However, gaining access to Chinese firms isn’t so easy, and is actually an alphabet soup of share classes and stock exchanges.
The most encountered share classes of Chinese firms for U.S. investors are B-Shares, H-shares, Red chips and N-shares. These classes are related to where they are incorporated — on the mainland or in Hong Kong — and in what currency they are traded — U.S. or Hong Kong Dollars. Where the security is listed also plays a roll.
For example, B-shares are Chinese companies incorporated on the mainland and traded in Shanghai and quoted in USD, while N-shares are Chinese stocks incorporated outside the mainland and are U.S.-listed on the NYSE or NASDAQ. China Mobile Limited (CHL) is a prime example of a Chinese N-share.
While it can be confusing, the key to this alphabet soup is that all of these B, H, N and red chip Chinese stocks are available in some form to foreign investors — either through a fund or directly. The previously mentioned FXI holds hold H-shares and red chips, while the PowerShares Golden Dragon China (PGJ) holds only N-shares.
Gaining Access To A-Shares
Which brings us to the crux of this article: those elusive A-shares.
China’s A-share can be thought of as the “real” Chinese stock market. These are firms which are incorporated on the mainland, listed on the Shanghai and Shenzhen exchanges and are denominated in local currency (the renminbi). And for most of us, they are strictly verboten to buy and trade. Restrictions prevent only certain institutional investors who have been granted a special status — called qualified foreign institutional investors (QFII) — to dabble in the A-share market. And Beijing doesn’t hand these out willy-nilly.
However, the game has been changed with ASHR’s launch.
Fund sponsor Deutsche Bank AG (DB) –- through an investment in China’s Harvest Fund Management — has been granted QFII status. Using that power, DB has created an ETF that tracks the 300 largest and most liquid stocks in the China A-share market … directly.
Previously, A-share tracking funds — like the Market Vectors China ETF (PEK) –- had to use swaps and derivatives to accomplish their goals. The use of swaps adds another entire layer of counterparty risk to the equation and investors have been cautious to buy in.
Yet, with ASHR holding actual shares of mainland Chinese firms, investors are now given unprecedented access to the bulk of Asia’s largest market. Aside from the access and diversification benefits — sector weightings in the A-share market are completely different than funds like the iShares MSCI China (MCHI) — China’s A-shares exhibit low correlation to other Chinese share classes and international markets. So there is certainly reasons to add A-shares, if you’re a China bull.
As for ASHR itself, the fund is off to an impressive start. While it is expensive — costing 1.08% or $108 per $10,000 invested — the expense could be worth it as it provides the only way to play China’s elusive stocks. For portfolios, all-inclusive access to one of the most dynamic emerging markets is now at hand.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities. But he does plan on adding ASHR within the next month.