Tuesday, November 27, 2012

First RMB-HKD Dual Currency Counters ETF (Harvest MSCI China A-share Index Stock Codes 83118.hk and 3118.hk) Analysis

Harvest MSCI China A-share Index ETF (Stock Codes: 83118.hk for RMB counter and 3118.hk for HKD counter) is the first RMB-HKD (Dual Currency Counters) ETF (Exchange Traded Fund) in the world. This is a physical (non-synthetic) ETF that tracks passively the benchmark MSCI China A-share Index and invests directly in PRC (People's Republic of China) domestic stock market using an initial RMB 2 billion RQFII (Renminbi Qualified Foreign Institutional Investor) quota. The ETF has been listed on the main board of HKSE (Hong Kong Stock Exchange Stock Code: 388.hk) since October 12, 2012, and is traded in both HKD (Hong Kong Dollars) and Renminbi (RMB, or called CNY or Yuan). Trading lot size is 100 units per lot (for both RMB and HKD counters). Hong Kong and Shanghai Banking Corporation (HSBC Stock Codes: 005.hk for Hong Kong, HSBA for London, HBC for New York) is the fund custodian, and PRC asset management company Harvest Global Investments (HGI) Ltd. is the fund manager (also fund issuer). We can now start looking into details of our stock analysis report with you:

Stock Analysis of the First RMB-HKD (Dual Currency Counters) Non-synthetic (Physical) A-share ETF in Hong Kong

(1) Underlying asset of this Harvest MSCI fund (Stock Codes: 83118.hk for RMB counter and 3118.hk for HKD counter) is intended to track primarily the benchmark MSCI China A-share Index performance by using full replication strategy. MSCI China A-share index is a market capitalisation-weighted and free-float adjusted index which is published by MSCI Inc (Morgan Stanley Capital International). MSCI China A-share index is classified as a price return index because it calculates passively the performance of index constituents with no distributions or dividends to be reinvested. In particular, Harvest MSCI China A-share Index ETF intends to cover 85% free-float market capitalisation of liquid Chinese A-shares being publicly traded on Shenzhen Stock Exchange (SZSE) as well as Shanghai Stock Exchange (SSE) in PRC markets and it does not use any representative sampling strategy.

Now let us list down the top 10 index constituents of Harvest MSCI China A-share Index ETF (as of November 23, 2012) as follow:

(Ranking) Name of Index ConstituentWeighting (Percentage)
(1) Ping An Insurance (Group Co.) of China Ltd. (PING AN INS)2.33%
(2) China Merchants Bank Co., Ltd. (MER BK)2.31%
(3) China MinSheng Banking Corp. Ltd. (MSBC)2.25%
(4) KweiChow MouTai Co., Ltd. (KC MOUT)1.75%
(5) Shanghai PuDong Development Bank Co., Ltd. (SHA PDDB)1.68%
(6) Industrial Bank Co., Ltd. (INDB)1.62%
(7) Bank of Communications Co., Ltd. (BK of Comm)1.62%
(8) China Vanke Co., Ltd. (VANKE)1.51%
(9) Citic Securities Co., Ltd. (CITIC SEC)1.49%
(10) Industrial & Commercial Bank of China Ltd. (ICBC)1.32%

Table: Top 10 Harvest MSCI China A-share Index ETF Constituents

We would also like to list down the sector allocation of Harvest MSCI China A-share Index ETF (as of November 23, 2012) as follow:

Sectors in MSCI China A-share Index% (Percentage)
Consumer Discretionary9.3%
Consumer Staples8.4%
Health Care6.31%
Information Technology3.6%
Telecommunication Services0.73%

Table: Sector Breakdown of Harvest MSCI China A-share Index ETF

The following stock price index chart directly compares the stock price performance levels of MSCI China A-share Index, Shenzhen A-Share Index as well as Shanghai A-Share Index from 2002 to 2012:

MSCI China A-share index comparison graph

Current MSCI China A-share Index Price Trend

Source: Prospectus and Product Key Factsheet of Harvest MSCI China A-share Index ETF (Stock Codes: 83118.hk for RMB counter and 3118.hk for HKD counter).

(2) The captioned fund is a sub-fund under the Harvest Fund Series. Now we list down in the following table its ongoing fee structure:

Fee(s) Payable by This Harvest Sub-FundAnnual Fee Rate (Percentage NAV)
Manager's FeeMaximum management fee can be 2% p.a. of NAV. This fee is calculated on each dealing day and is payable monthly in arrears.
Current Fee Structure: 0.7% p.a. of NAV.
Administration and Performance FeesIncluded Already in Manager's Fee.
Trustee's fee (for payments to Custodian and PRC Custodian)Maximum trustee's fee can be 2% p.a. of NAV. This fee is calculated on each dealing day and is payable monthly in arrears.
Current Fee Structure: 0.1%.
Registrar FeeAn ongoing registry service fee of RMB 120 per participating dealer per transaction and ongoing administrative transaction fee of RMB 25K per participating dealer per transaction.
Service Agent FeeAn ongoing fixed reconciliation fee of HKD$5K per month.
Total Expense Ratio (TER)Currently 0.88% p.a. of NAV (estimated percentage by the Harvest Management)

Table: Structure of Ongoing Fees for Harvest MSCI China A-share Index ETF

(3) Annual Dividend Policy: The fund Manager, Harvest Global Investments (HGI) Ltd., is intended to distribute its net income (after all costs and fees) to unit-holders in RMB at least annually (every October from 2013 onwards). Dividend distributions (no matter using RMB or HKD counter) will only be in RMB and will not in HKD.

(4) Similar to other index-tracking Exchange Traded Funds (ETFs), this Harvest MSCI A-share ETF is subject to tracking-error risks for the reason that it is not being hedged for foreign exchange-rate or currency risks. It is also subject to passive investment risks for its passively-managed nature. In addition, it should suffer from concentration risk (as it solely invests on the mainland China A-share assets), political or regulatory risks in PRC (due to the nature of emerging market). You should, however, also be aware of other unique risk factors for this Harvest fund as follow:

(4a) RMB Liquidity and Currency-related Risks.

As the base currency of this Harvest ETF, now Renminbi (RMB) cannot be freely convertible and is still subject to PRC exchange-rate controls or restrictions. Although offshore RMB deposits in Hong Kong has already reached a record high level of RMB 563 billion (by end-July 2012) that can theoretically form a large liquidity pool for this Harvest fund, significant portion of such deposits is just for trade settlement (not for capital account investment). In order to cope with the potential issue of insufficient RMB liquidity pool, SEHK (Hong Kong Stock Exchange) has already introduced a RMB Equity Trading Support Facility (TSF) which can allows investors without sufficient RMB to purchase RMB-denominated securities, however, the Harvest fund manager still needs to rely heavily on market maker or participating dealer to provide enough liquidity for its RMB currency counter.

(4b) RQFII-related Risks.

Harvest MSCI China A-share Index ETF is currently traded with an initial RMB 2 billion RQFII (Renminbi Qualified Foreign Institutional Investor) quota that is granted to Harvest by PRC's State Administration of Foreign Exchange (SAFE) for introducing foreign investment capitals into domestic equity markets. By definition, RQFII is a Renminbi-version of traditional QFII regime but it does not require any currency conversion from or to USD in the mainland China. As RQFII policy is still relatively new for CEPA implementation that helps achieving RMB internationalisation in Hong Kong offshore forex market, this Harvest fund may be subject to risks of any potential RQFII policy change or insufficient RQFII investment quota in the future. Under worst-case scenario, Harvest will have to suspend new fund unit creation when RQFII quota is being used up, and then its stock price will have very high premium (i.e.: very expensive) to its net asset valve (NAV) of each unit fund.

(4c) New Fund Manager and New Product Risks.

The fund manager, Harvest Global Investments (HGI) Ltd., may rely too heavily on its expertise or investment adviser HFM (Harvest Fund Management Co. Ltd) as HGI itself has zero or only limited past experience of managing other ETFs.

In addition, being the first dual-currency counters physical A-share ETF in SEHK (Hong Kong Stock Exchange), novelty and untested nature of this new product can possibly increase its risk level over other existing ETFs. It is also possible that its market price trading in RMB on SEHK and that trading in HKD may deviate significantly because of various factors like general market liquidity, demand or supply in each currency counter, as well as exchange rate fluctuation between HKD and RMB in either offshore or onshore forex markets. If for whatever reasons the inter-counter fund unit transfer between RMB counter and HKD counter is suspended, investors will then be able to trade their fund units only in respective counter (i.e.: only one currency counter) on SEHK.

(4d) PRC Taxation-related Risk.

This Harvest fund is subject to PRC taxation policy risk. Despite PRC tax department still has not enforced capital gains tax (CGT) on RQFII funds, Harvest MSCI China A-share Index ETF already collects 10% of total fund assets as provision to prevent from any possible taxation liability for capital gains. As PRC tax department may not eventually collect any capital gains tax (CGT) at all, Harvest's tax provisions made can be too excessive (because it simply reduces the fund's net asset value).

(4e) Risks Relating to PRC brokerage and Trading differences.

PRC brokerage policy now allows appointing only one brokerage in every stock market (i.e.: only one in Shenzhen Stock Exchange and in Shanghai Stock Exchange) to perform A-share securities transactions on behalf of any RQFII ETF including this Harvest fund. Once the designated brokerage fails, fund operation of this ETF must be impaired and may then not be able to accurately track MSCI China A-share Index (underlying index).

On the other hand, stock markets in PRC and Hong Kong have difference securities trading days (holidays or settlement days etc) as well as standard trading hours. More than that, domestic A-shares being traded in the mainland China are subject to trading-band limits which restrict maximum loss or gain in share prices. Since this Harvest MSCI China A-share Index ETF is listed in Hong Kong instead of PRC, such trading-band limits are not applicable to this fund. All the above brokerage and trading differences can put more risks to investors by extending the premium (or discount) level of Harvest fund's stock price to its net asset value (NAV).

(4f) Early Termination Risk.

It is possible that this fund will be terminated early, in cases if its size falls below RMB 180 million or MSCI China A-share Index can no longer be adopted as its benchmarking index.

Short Conclusion of This Stock Analysis:

Harvest MSCI China A-share Index ETF (Stock Code: 83118.hk for RMB counter) closed at RMB 7.98 on its first debut day (October 12, 2012), a slight drop from its issue price of RMB 8, while for HKD counter (Stock Code: 3118.hk) it closed at HKD 9.88 at foreign exchange rate of 1.236. As the underlying index (MSCI China A-share Index) closed at 2216.88 the same day, estimated NAV (net asset value) per unit were RMB 7.96 and HKD 9.84 respectively. Thus this Harvest fund was traded (RMB 7.98) at a slight premium (+0.25%) share price to its NAV per fund unit (RMB 7.96). Taking into account all the above-mentioned risk factors and by using the same formula we applied for calculation of our A50 China ETF fair value (Source: our own estimation for A50 China ETF), our target NAV (Net Asset Value) per each Harvest MSCI China A-share fund unit is RMB 8.5, based upon our own estimation of PRC stock market performance (Source: our own estimation for 2012 Shanghai SSE Index).

As we anticipate that in the long run, driven by the simple supply-and-demand rule due to the limited nature of RQFII quota to PRC equity markets, this Harvest fund is likely to continue trading at premium price to its NAV (Net Asset Value) per unit. By using the current premium level of +0.25%, our calculated stock price target (which we call it a fair value) of this Harvest MSCI China A-share ETF shall become RMB 8.5 x (1 + 0.25%) = RMB 8.52. According to this fair value level of RMB 8.52, the current Harvest MSCI China ETF stock price level of RMB 7.55 (as of November 23, 2012) should be rated 'not expensive'. Thus we will recommend a sell once its share price hits RMB 9.81 (our expensive rating level), or will recommend a buy once it hits RMB 7.23 (our cheap rating level). Rating Info Source: Classification of Rating System.

Owing to the unique natures of this new Harvest MSCI China A-share Index ETF (Stock Codes: 83118.hk for RMB counter and 3118.hk for HKD counter), it may become a key competitor of the leadting iShares A50 China ETF (Stock Code: 2823.hk) which is a synthetic open-end and HKD-denominated exchange traded fund. This Harvest fund is an appropriate entry point for longer-term overseas investors who are bullish towards the emerging Chinese A-share equity markets, especially when A-shares are still only available to China domestic residents or large institutional investors who can get QFII (Qualified Foreign Institutional Investor) quota in USD or RQFII quota in RMB.


Since the initial offer of this Harvest MSCI China A-share Index ETF (Stock Codes: 83118.hk for RMB counter and 3118.hk for HKD counter) was only available to institutional investors with RMB as its base currency, there was actually no IPO (Initial Public Offer) and no HKD initial offer. Therefore it was just similar to adding HKD as a new trading currency counter to RMB-denominated ETF to make it dual-currency. It still could not be entitled the first DTDC (Dual Tranche, Dual Counter) listing as defined by HKEx (Hong Kong Stock Exchange). Some new sources called it the first DTDC in Hong Kong should, however, not be a correct description.

On the contrary, Singapore, a key competitor against Hong Kong in Asian IPO business, had almost launched the first RMB DTDC (Dual Tranche, Dual Counter) listing there. Dynasty REIT (Real Estate Investment Trust), spin from ARA Asset Management owned by Hong Kong richest man Li Ka-Shing, had wanted to run for the first SGD-RMB dual-currency IPO on October 30, 2012 on Singapore Exchanges, but just unfortunately suspended due to poor market condition. Dynasty REIT has real estate assets in Shanghai, Nanjing and Dalian.

In fact, Singapore has become more and more competitive as she wants to be an alternative offshore RMB centre against London, Tokyo, Taipei, Luxembourg, Kuala Lumpur, Malaysia another than Hong Kong. Before Dynasty REIT, Singapore already had Li Ka-Shing's HPH Trust (Hutchison Port Holdings Trust) added SGD (Singapore Dollar) counter from existing USD counter to make it the first SGD-USD dual-currency trading stock there since April 2, 2012. Li Ka-Shing, who owns HPH's mother company Hutchison Whampoa Ltd. (Stock Code: 013.hk), did successfully run the first-ever RMB IPO in Hong Kong earlier on April 29, 2011. Source: Hui Xian 87001.hk.

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Summary Table: List of All Mr China's Stock Analysis Reports


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