Niche ETFs Are Winning Over Chinese Investors

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Chinese investors are souring on exchange-traded funds that track broad indexes, but they’re snapping up thematic—or ­sectoral—ETFs, such as those that invest in the nation’s Science and Technology Innovation Board.

In one week through March 2, Chinese asset managers raised $1.7 billion for four funds that purely invest in ETFs that track the stocks listed on the two-year-old Nasdaq-style board in Shanghai, known as the STAR Market. And last year, four STAR Market ETFs received 100 billion yuan ($15.4 billion) in subscriptions from retail investors in a 24-hour period, the fastest takeup in the 16-year history of Chinese ETFs.

Niche ETFs that capitalize on sectors such as alternative energy or technology have also been hot in the U.S. as investors chase broad investment themes during the pandemic. The difference is that in the U.S., the whole ETF sector is booming. Net inflows into the funds rose 23%, according to data compiled by Bloomberg. In China, by contrast, inflows rose just 9%—the slowest pace in three years.

“The chase for ‘alpha’—index-beating return—became particularly popular in China last year,” says Lu Yayun, vice president at China Asset Management Co., which sells China’s oldest ETF and, according to broker China International Capital Corp., makes up a quarter of the country’s total equity ETF market by value. “Broad ETFs only represent benchmark returns, which are far less than returns from active mutual funds or ETFs tracking well-performing sectors.”

Last year there were more thematic ETFs than index ETFs for the first time since the launch of the China AMC SSE 50 ETF in ­December 2004, the country’s first. China AMC SSE 50, the country’s largest equity ETF by assets under management, tracks the 50 largest stocks on the Shanghai Stock Exchange. So far in 2021, dragged lower by redemptions from the $8.7 billion China AMC SSE 50 ETF, China’s 282 equity ETFs recorded a net outflow of $1 billion as of March 16.

Niche ETFs Are Winning Over Chinese Investors

One reason is added cost. Chinese ETFs typically charge management fees of about 0.5% of total assets, while U.S. ETF fees can be as low as 0.05%, according to Ray Chou, Shanghai-based partner at Oliver Wyman.

So instead of looking for savings, investors are seeking ETFs that give them an edge. For example, the STAR Market ETFs provide a way to own STAR Market stocks that are normally available only to buyers with at least 500,000 yuan in a brokerage account.

China’s heavy retail investor base, which generates as much as 80% of the stock market’s volume (compared with about 20% from retail in the U.S.), has also shown an increasing preference for stockpicking or star mutual fund managers, as the overall market climbed 65% from last March’s low to a 13-year high in February.

“Chinese investors invest passively when they are less confident about stocks, but they are bullish now, so they would rather pick themes or follow star mutual fund managers,” says Dai Ming, fund manager at Hengsheng Asset Management Co.

The $11 billion E Fund Blue Chip Selected Mixed Fund, for instance, helmed by star manager Zhang Kun, saw its asset size more than double in the fourth quarter of 2020—though it lost value in a recent market rout. Zhang made his name as an early investor in the country’s most valuable domestic stock, Kweichow Moutai Co., the $393 billion distiller of the fiery liquor baijiu. He now has a fan page on China’s social media platform Weibo with 15,000 followers and 37 million hits.

One of China’s most popular ETFs this year, the HuaAn CES Hong Kong Stock Connect Selected 100 ETF, focuses on Hong Kong-listed tech stocks and has garnered inflows of $98 million as of March 16. And two of China’s thematic ETFs are among the world’s biggest: The Guotai CSI All Share Communication Devices ETF, set up in 2019, was the world’s ninth-largest telecommunications ETF, and the China Universal CSI Consumer Staples Index ETF, launched in 2013, ranked as the 10th-largest consumer-staples ETF globally, according to a January report by Chinese broker CICC.

“Last year, when China’s benchmark Shanghai Composite Index rose, actually half of stocks listed on the index fell—which shows how difficult it is to pick stocks,” says China AMC’s Lu. ­“Thematic or sector ETFs give people a clear exposure to hot stocks.”

As with any popular product, investors need to beware of a sudden change in market sentiment. For instance, this year the Guotai CES ­Semi-conductor Industry ETF has seen a reversal of the big inflows it received in 2020.

China’s biggest ETF managers—China AMC, Guotai, and E Fund, which together account for 40% of market share—have the advantage so far in an extremely competitive market, says Oliver Wyman’s Chou. But they soon may face a bigger challenge from giants including Vanguard, State Street, and BlackRock, which account for about 80% of the U.S. ETF market.

Vanguard Group Inc., the index fund pioneer, withdrew from Hong Kong and Japan late last year to prioritize growth in China, where it plans to focus on developing through its partnership with Alibaba Group Holding Ltd. affiliate Ant Group Co. Meanwhile, New York-based BlackRock Inc., which manages $8.68 trillion in assets, received China’s approval to set up a fund management company on the mainland in August 2020. (Previously fund managers needed to have local partners.) It’s waiting for authorization to sell products.

China’s ETF market grew to a record $177 billion at the end of last year, according to Bloomberg data, but it’s still just a fraction of the country’s $11 trillion stock market. In the U.S., ETFs make up about 10% of the $46 trillion market.

“We are encouraged by the rapid growth of China’s ETF market,” Susan Chan, BlackRock’s head of Asia, said in a statement. “As China continues to open its capital market, we believe raising investors’ awareness on the benefits of using ETFs on offshore exposures in their investment portfolio will foster the development of the China ETF market.”

Yu is a China markets reporter for Bloomberg News in Hong Kong.

©2021 Bloomberg L.P.

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