China ETF: Foot in the Door to Foreign Investing

Amid tight capital controls, new fund may represent Chinese test of asset classes and wider geographical exposure

The potential of China’s vast markets has long caught investors’ imaginations, but in the case of asset management at least, market progress has not kept pace with the Asian giant’s rapid economic growth. But the approval by Chinese regulators of the country’s first ETF linked to Hong Kong’s Hang Seng China Enterprise Index represents a cautious opening for China’s tightly controlled capital markets.

The China Securities Regulatory Commission this week authorized Guangzhou-based E Fund Management to market the Hong Kong ETF to Chinese mainland investors. China maintains tight control over financial markets, severely limiting the extent to which capital can enter or exit the country. Hong Kong, though under Chinese sovereignty, is considered offshore for purposes of Chinese investing.

According to a new report by Cerulli Associates, which monitors global asset management developments, overseas investments by Chinese mutual fund managers amount to just $11 billion–a mere 3.2% of total assets under management as of June 2011. And that international diversification is not all that foreign. Cerulli, in the Asia-Pacific edition of its Cerulli Edge first quarter 2012 report, says that sliver of offshore investing is mostly invested  in Hong Kong (58%), with the next largest segment of investments allocated to other Asian markets (18.7%).

Opportunities for Chinese investors in foreign markets have a fairly narrow window. A 2011 report by KPMG says that just 95 Chinese firms have been granted the legal status to pursue such investments, and total investments for the firms cannot exceed $68.4 billion.

Cerulli in its report predicts that “eventually, the Chinese regulators will conclude that it is in investors’ best interest for the mutual fund industry to have more room to maneuver around asset classes, geographical exposures, hedges, and fund structures. As is customary, Chinese authorities will test the ground before proceeding.” E-Fund’s new ETF, and unconfirmed reports of a second ETF launch, would seem to fit into Cerulli’s analysis.

Meanwhile, there is no stopping the explosive growth of ETFs in the U.S., including opportunities for U.S. investors to invest in China.  According to ETFGuide.com founder (and AdvisorOne contributor) Ronald DeLegge, “Advisors can dial in on whichever aspects of Chinese markets they want to focus on.” DeLegge says there are 26 China-oriented exchange-traded products distributed across the asset-class spectrum, including equities, fixed-income, currency and long-short funds.

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