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Morningstar's Guide to Investing in Chinese Stocks via ETFs

As China's prominence in global stock markets rises, so does the need to understand the intricacies of investing in Chinese stocks. 

Morningstar, 08/16/2013

The Chinese economy and equity market continue to demonstrate their importance and impact on the global economy and markets. Our global exchange-traded fund research team has just published "Morningstar's Guide to Investing in Chinese Equities via ETFs" to help investors better understand the nuances of investing in Chinese stocks. The report also gives a comprehensive overview of the global menu of ETFs offering exposure to Chinese equities and highlights key considerations that investors should take into account before making an investment decision.

"As China continues to open its financial markets to the world, Chinese equities are moving towards an increasingly important position on the global investment stage. We hope this guide will provide a useful road map for investors trying to better understand how they can use ETFs to gain access to the Chinese stock market as well as the associated risks," said Ben Johnson, director of Global Passive Fund Research at Morningstar.

Here is the executive summary from the report:

  • China's representation in major equity indices ranges from 2% in the MSCI ACWI Index to 18% in the MSCI Emerging Markets Index. In June 2013, MSCI announced it had initiated a review of China A-Shares for potential inclusion in the MSCI Emerging Markets Index. If China A-Shares were hypothetically included, China would make up close to 30% of the MSCI Emerging Markets Index. However, in our view, this is unlikely to transpire in the near-term as there are still hurdles to inclusion, namely (according to MSCI): "1) capital mobility, 2) the lack of alignment of the size of individual Qualified Foreign Institutional Investor (QFII) quota and the size and investment process of investors, and 3) the lack of clarity on taxation rules."
  • The further opening up of China's capital market and the internationalization of the RMB are a trend that investors and ETF providers should watch closely. In particular, in July 2013, the China Securities Regulatory Commission (CSRC) announced it would expand the RMB Qualified Foreign Institutional Investor (RQFII) scheme, which allows qualified institutional investors to invest directly in Chinese securities, to London and Singapore. We expect that this will lead to the launch of RQFII ETFs in additional countries outside of Hong Kong.
  • As of today, there are over 50 country, sector, and strategy indices tracked by approximately 100 Chinese equity ETFs listed on various exchanges outside China, with a combined USD 28 billion in assets under management (AUM).
  • Chinese companies listed in different markets are classified under different share types/names. They could be classified as onshore or offshore Chinese equities; and then further subdivided into A-Shares, B-Shares, H-Shares, Red Chips, and P Chips, etc. It is important that investors make sense of this veritable alphabet soup to truly understand their economic exposure. 
  • Indexes tracking Chinese equities are constructed quite differently from one another and as such have very different historical risk/return profiles. These distinctions are particularly pronounced, between onshore and offshore Chinese equity indexes. These differences are especially evident amongst the crop of offshore indexes. Hence it is crucial that investors closely scrutinize these indexes to ensure that they choose the one that best matches their investment thesis.
  • It is important that investors assess and understand the risks associated with these ETFs at all times. These risks include ETF-specific structural risks, market risks and currency risks as well as A-Share specific considerations regarding taxation and the potential for quota-related premiums and discounts. At the end of the report, we include 10 frequently asked questions that we believe every investor should be able to answer before investing in Chinese equity ETFs.  

The complete guide is available here


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