Fund selectors looking to capture onshore Chinese equities can take advantage of a unique structural dynamic via swap-based ETFs.
Onshore China is known for its high retail participation which is an attractive environment for hedge funds to capture alpha.
However, these hedge funds suffer from access issues to A-Shares as there is not a physical securities lending market for offshore investors.
As Christopher Mellor, head of EMEA ETF equity product management at Invesco, told ETF Stream: “Quant desks and hedge funds running market-neutral strategies do not have access to traditional methods for hedging market risk via stock lending so they often use index derivatives written by banks to get this exposure.
“An ETF offering synthetic replication of an A-Shares index can benefit from this demand for index swaps as they offer banks a way of hedging their own exposure to these contracts and receive an attractive level of swap pricing delivering outperformance for an onshore China ETF.
“In terms of the ETF, it provides a good vehicle for the banks to offset that exposure they have taken with the hedge fund.”
Performance uptick
ETF returns for China A-Shares from swaps have hit double-digits annually in recent years, highlighting the potential performance advantage versus physical exposure.
DWS currently offers the largest synthetic China A-Shares ETF in Europe, the Xtrackers CSI300 Swap UCITS ETF (XCHA) which has $1bn assets under management (AUM), as at 24 June. XCHA tracks the CSI 300 index which offers exposure to the 300 largest equities listed on the Shanghai and Shenzhen Stock Exchanges.
Highlighting the structural performance advantage, XCHA has outperformed the CSI 300 by 95.9% over the past decade, as at 24 June.
It is a similar story for the $11m Invesco S&P China A 300 Swap UCITS ETF (C300), which launched in May 2022 and has fallen 11.2% since inception versus -14.6% returns for the S&P China A 300 index.
“Although DWS trade swaps on a termed basis with a fixed maturity, the repo curve can be volatile depending on sentiment, market and broker activity which consequently means the premium received for lending Chinese CSI 300 stocks can vary over time,” Jamie Hartley, regional head of capital markets, Europe and Asia, at DWS, explained.
“The limited ability to borrow and short China local stocks has a material impact on the repo rate. During periods where appetite to short local stocks of the CSI 300 increases, these can cause an increase in the respective repo rate, driving more negative swap spreads.”
Final word
The Chinese market has shown signs of life in recent months. As fund selectors, this should be an important consideration when conducting due diligence on the China A-Shares ETFs listed across European exchanges.