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ETF Specialist

Investing in China: Getting Around the Great Wall

An A-Share ETF provides more diversified exposure but has a unique structure and carries additional risks.

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Improving Chinese economic data and relatively low valuations have attracted strong inflows into Chinese equity exchange-traded funds over the past few weeks. Many assume a cap-weighted ETF provides broad and direct exposure to a country’s stock market. But the Chinese equity universe is different because China continues to maintain tight capital controls. Mainland China-listed A-Shares that trade in Shanghai and Shenzhen are not accessible to most foreign investors; as a result, most China index funds domiciled outside of China invest only in Chinese companies whose shares are listed in Hong Kong (H-Shares, Red Chips, and P-Chips) and/or New York. So, while the total universe of Chinese equities includes shares listed in China, Hong Kong, and New York, only about 30% (as measured by market cap) is readily investable by foreign investors. For an in-depth explanation of the differences among A-Shares, B-Shares, H-Shares, Red Chips, and P-Chips, please refer to my Hong Kong-based colleague Jackie Choy's article on the topic.

Over the past few months, the Chinese government has made some moves to open up the domestic Chinese equity market and attract more institutional investors. Starting in 2002, foreign institutional investors who want to purchase domestically listed securities, or A-Shares, had to be granted a qualified foreign institutional investor license, or a QFII. Although this program has been in place for more than a decade, the Chinese government has kept investment quotas low, so foreign ownership still accounts for a very small 1%-2% of the local Chinese market. However, the Chinese government is now planning to significantly expand the QFII program (as well as its RQFII program, which is currently aimed at Hong Kong investment firms), as part of its overall efforts to liberalize its capital markets and currency.

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Patricia Oey does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.