Intervention amplified losses for ETFs tracking China mainland

Thu Sep 17, 2015 1:14am EDT
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By Tim McLaughlin and Jessica Toonkel

BOSTON/NEW YORK (Reuters) - Just as China shows that its domestic stock market can be something of a one-way street -- investors can put money in, but not take money out – the biggest mutual fund company, Vanguard Group, is moving ahead with plans to expose more mom-and-pop investors to the country's heavily restricted exchanges.

With the Shanghai stock exchange down by 37 percent and the Shenzhen exchange off by 43 percent during the past three months, compared with just an 18 percent drop on Hong Kong's Hang Seng Index, Vanguard is adding China mainland stocks to its $60 billion emerging markets fund in the coming year.

Vanguard says adding A-shares – stocks that trade on the Shanghai and Shenzhen exchanges, as opposed to those that trade on the Hong Kong exchange -- will diversify the fund, but acknowledges they pose unique risks related to tracking a benchmark. Steps taken by the Chinese government to restrict trading on domestic exchanges make it difficult for index funds to buy the stocks they need to replicate the performance of Chinese benchmarks, fund executives said.

When China halted most trading on the Shanghai and Shenzhen exchanges in July, for example, a Deutsche Bank exchange traded fund, the Deutsche X-Trackers Harvest CSI China A-Shares ETF, was thrown so far off track that its losses for the year have now more than doubled the index's. As of Sept. 14th, the year-to-date market price of the fund was down 14.86 percent compared to the 7.15 percent drop on the index, according to Lipper Inc data.

"Certain days had more than 50 percent of the portfolio not trading," said Dodd Kittsley, head of ETF strategy in the Americas at Deutsche Bank AG's Deutsche Asset & Wealth Management unit.

The Deutsche ETF tracks the CSI300 Index of the largest listed companies in Shanghai and Shenzhen. The fund closely tracked the index earlier in the year, according to Lipper data. In early July, the fund was no longer able to track the index as well as before after more than 1,000 mainland Chinese companies suspended trading to break the market's free fall, and in doing so took $2.4 trillion worth of stock out of play.

To combat the effects of any future trading halts, the $11 million KraneShares Bosera MSCI China A ETF has amended its registration so it can buy similar stocks outside its benchmark, if needed.

"Since we invest in the big liquid names, we didn't think it would be an issue," said Brendan Ahern, chief investment officer of New York-based KraneShares.      Continued...

Investors look at computer screens in front of an electronic board showing stock information at a brokerage house in Shanghai, China, in this file picture taken September 7, 2015. REUTERS/Aly Song/Files