This ETF was previously named iShares FTSE/Xinhua A50 China Index ETF in Hong Kong and has also been trading on the U.S. pink sheets (Stock Code: IFXAF.PK). Now we would like to publish our analysis report for this ETF as follow:
(1) The underlying asset of this iShares index fund intends to track and replicate synthetically the performance of top 50 publicly traded liquid A-shares (by total free-float weighted market capitalization) listed on the Shanghai Stock Exchange (SSE) as well as the Shenzhen Stock Exchange (SZSE) in the mainland China. Here is the sector breakdown in percentage for these top 50 A-shares as of April 30, 2012:
| Sector Breakdown | Percentage (%) |
|---|---|
| Financials | 60.96% |
| Industrials | 10.72% |
| Consumer goods | 9.53% |
| Basic materials | 8.13% |
| Oil and gas | 3.28% |
| Consumer services | 2.54% |
| Utilities | 1.61% |
| Telecommunications | 1.49% |
| Technology | 1.44% |
We can easily conclude that the index fund is investing heavily (over 60%) in Chinese financial sector. Now let us take a closer look at its top 10 holdings as of April 30, 2012:
| Name of Holding | % NAV (Net Asset Value) | Sector | Stock Code(s) | Trading Platform |
|---|---|---|---|---|
| Ping An Insurance Group Co. (PAIG) | 7.9% | Financials | 601318.sh for A-shares (2318.hk for H-shares) | Shanghai Stock Exchange (SSE) |
| China Merchants Bank Co. Ltd (CMB) | 6.55% | Financials | 600036.sh for A-shares (3968.hk for H-shares) | Shanghai Stock Exchange (SSE) |
| Shanghai Pudong Development Bank (SPD) | 5.34% | Financials | 600000.sh for A-shares | Shanghai Stock Exchange (SSE) |
| Bank of Communications Co. Ltd. (BoCOM) | 4.89% | Financials | 601328.sh for A-shares (3328.hk for H-shares) | Shanghai Stock Exchange (SSE) |
| Industrial Bank Co. Ltd (IBC) | 4.7% | Financials | 601166.sh for A-shares | Shanghai Stock Exchange (SSE) |
| China MinSheng Banking Corp. Ltd (MSBC) | 4.57% | Financials | 600016.sh for A-shares (1988.hk for H-shares) | Shanghai Stock Exchange (SSE) |
| CITIC Securities Co. Ltd (CITIC) | 3.88% | Financials | 600030.sh for A-shares (6030.hk for H-shares) | Shanghai Stock Exchange (SSE) |
| KweiChow MouTai Co. Ltd (KCMT) | 3.8% | Consumer Goods | 600519.sh for A-shares | Shanghai Stock Exchange (SSE) |
| China Vanke Co. Ltd (VANKE) | 3.51% | Financials | 000002.sz for A-shares | Shenzhen Stock Exchange (SZSE) |
| Industrial and Commercial Bank of China (ICBC) | 2.8% | Financials | 601398.sh for A-shares (1398.hk for H-shares) | Shanghai Stock Exchange (SSE) |
In the above table, stock codes of H-shares, if any, are just for foreign investor reference only. This index fund does not own any H-shares at all.
As the top 5 holdings all financial sector stocks (and only one non-financials in the top 10 list), it is clear that you have to be bullish towards Chinese financial sector if you choose to invest in this iShares ETF.
The underlying benchmark index of the iShares A50 is the quarterly rebalanced 'FTSE China A50 Index' published by the FTSE (Financial Times Stock Exchange) International Ltd and its base currency is Renminbi (RMB, also named CNY).
By the end of 2011, the FTSE China A50 Index dropped by -13.45% YoY (was -19.29% YoY in 2010) while the NAV (Net Asset Value) per fund unit of A50 China ETF dropped by -15% YoY (was -21.34% YoY in 2010).
Here is the current stock price trend of the Index Fund (quoted in Hong Kong Dollars HKD):
Below please find its historical returns:
Max value = 26.84% (maximum premium in December 2006)
Min value = -26.49% (maximum discount in August 2009)
(2) This iShares ETF, however, does NOT directly hold or invest in any A-Shares. It is only a synthetic ETF with an investment strategy called SRSS (Synthetic Representative Sampling Strategy). In fact, the ETF invests primarily in A-shares derivative instruments called CAAPs (China A-Share Access Products).
How do the CAAPs actually work?
In the past, the iShares fund manager (BlackRock Asset Management North Asia Ltd) controlled the exposure of each CAAP issuer to less than 10% of the total NAV (Net Asset Value). Effective October 31, 2011, BlackRock should seek additional collateral from any CAAP issuer to make sure there would be no uncollateralized counterparty risk (UCR) exposure. (Remark: eligible collateral of the fund are cash, government bonds or liquid listed common stocks). This full collateralization requirement already caused a sharp rise in liabilities of the index fund in 2011 due to cash collateral payable for securities on loans. For this reason, the total liabilities of A50 China ETF increased to HKD$ 21.4 billion (by end-2011) from only HKD$ 108.8 million (by end-2010), in which liabilities due to collateral arrangements also jumped to HKD$ 100 million in end-2011 (was only HKD$ 21.4 million in end-2010). Source: 2011 Annual Report of iShares A50 FTSE China Index (Stock Code: 2823.hk).
The index fund, however, is still subject to counterparty risk regarding each CAAP guaranteed itself or the mother company of each CAAP issuer who acts as its guarantor based on the corresponding credit rating(s). The loss due to this kind of risk, if any, could be significant enough to cause a drop in the NAV (Net Asset Value) of the ETF and could make it difficult to achieve its original investment objective.
(3) This A50 ETF is a sub-fund of the iShares Asia Trust. Its ongoing fee structure is shown below:
| Type of Fee(s) | Annual Fee Rate (% of NAV) |
|---|---|
| Management Fee | 0.99% p.a. of NAV (calculated on daily basis) |
| Custodian and Administration Fees | Included already in the Management Fee |
| CAAP Commission | 0.3% (stamp duty excluded) on each CAAP purchase or sale |
| CAAP Maintenance Charge | 0.3% p.a. (mark-to-market on daily basis) |
| Costs For Full Collateralization | Varies |
| Total Expense Ratio (TER) | 1.39% p.a. (expected value of the Management) |
(4) Fund Dividend Policy: The index fund may reinvest cash dividends, pay or distribute dividends to shareholders annually (if any). Below please find its distributions history:
| Payable (Year) | Total Distribution (in HKD$) |
|---|---|
| 2005 | $0.035 |
| 2006 | $0.05 |
| 2008 | $0.185 |
| 2009 | $0.11 |
| 2010 | $0.13 |
| 2011 | $0.17 |
(5) Similar to the other index-tracking fund, this A50 ETF is also subject to tracking error risks (because it is not hedged for foreign exchange rate and currency risks) or passive investment risks (because it is a passive index-tracking fund). It is subject to concentration risk (because it is investing only in Chinese A-share assets) as well. In particular:
(5a) CAAPs (China A-Share Access Products) are linked primarily to A-Shares (or the underlying benchmark index) and seek to replicate synthetically the target performance just like holding the underlying A-Shares in RMB. As a result, this index fund is subject to risks relating to the insufficient QFII (Qualified Foreign Institutional Investors) investment quota or the possible change of QFII rules in the future. In the extreme worst-case market situation, no further CAAPs might be issued and the ETF could then be terminated.
(5b) The ETF is subject to taxation risk (because PRC capital gains tax not yet collected). By now PRC tax authorities have not enforced capital gains tax (CGT) from QFIIs for selling A-Shares. It is a risk factor that PRC tax authorities can collect CGT (capital gains tax) for 10% of any gain immediately without prior notice or can even collect it on a retrospective enforcement basis. Since tax provisions have never been made at the A50 fund level and hence any such retrospective enforcement can induce significant loss to the fund.
Conclusion of Our Analysis:
Based on the above factors and our calculated target of Chinese stock markets, including Shanghai Composite Index (Source: our 2012 SSE target is 2358, though it is subject to change), we anticipate that the target NAV (Net Asset Value) per fund unit of A50 China ETF should be HKD$ 10.13 (fair value) in 2012.
Owing to supply-and-demand principle (QFII quota is not unlimited), the ETF often trades at a high premium to the NAV (Net Asset Value) per fund unit. Despite of this, the premium (or discount) of the index fund has been highly volatile. Historically its premium could hit +23.43% (this happened in May 2006) and its discount could also hit -16.64% (that happened in June 2007), although recently its stock price still has a premium staying approximately at +3.95% (latest monthly average value) over its NAV per fund unit. By using the all-time-average of ETF premium (or discount) which is calculated as +3.59%, we anticipate that the target stock price of this iShares ETF should be HKD$ 10.13 x (1 + 3.59%) = HKD$ 10.5 (fair value) in 2012.
Under the fair value at HKD$ 10.5, the current A50 stock price level of HKD$ 10.64 (as of May 28, 2012) should thus be rated 'reasonable'. We would recommend a buy if its stock price hits HKD$ 8.92 (cheap rating), or we would recommend a sell if it hits HKD$ 12.1 (expensive rating). Reference: Our Rating Criteria.
There are quite some major competitors of the fund, they are the opened-end DBX CSI 300 Index Fund (Stock Code: 3049.hk) or SSE 50 Index Fund (Stock Code: 3024.hk) listed in Hong Kong, and Morgan Stanley China A-Share Fund (Fund Code: CAF), which is a closed-end and active managed index-tracking fund listed in the U.S. etc. The iShares A50 FTSE China Index ETF (Stock Code: 2823.hk), however, is still the most liquid A-shares fund out there and is suitable for emerging market investors who are long-term bullish towards Chinese financial sector. After all, it is a good choice for entry to A-share markets since A-shares are still restricted for trading by Chinese domestic residents and Qualified Foreign Institutional Investors (QFIIs) only.
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