China is the latest emerging-markets country to open up to direct foreign investment. The first exchange-traded fund in the U.S. to tap into that has been an immediate success: Deutsche Bank’s db X-trackers Harvest CSI 300 China A-Shares Fund (ASHR).
ASHR was launched on November 6 in partnership with Harvest Global Investments, a Hong Kong–headquartered firm that has renminbi qualified foreign institutional investor (RQFII) status. This designation is part of a program established by China in 2011 that allows a small number of Chinese firms to create renminbi-denominated funds in Hong Kong for foreign investment in companies listed on the Shenzhen and Shanghai stock exchanges.
ASHR is the first U.S. ETF to offer direct access to shares of companies that make up the CSI index of 300 stocks, China’s equivalent of the S&P 500 index. The ETF debuted with $108 million in seed capital and has since grown to $199.3 million in assets. In its short life, it has already traded more than a million shares in a single day and posted a 4.36 percent gain.
ASHR opens new possibilities in terms of types of companies available to overseas investors. While some of the largest Chinese companies are listed in Hong Kong or New York, there are important Chinese companies that can only be accessed through the A-shares market, notes Amrita Bagaria, the ETF product manager at New York–based Van Eck Associates, which also announced November 6 that it was negotiating with a subadviser to get an RQFII allocation for its Market Vectors China ETF (PEK), which has been using derivatives to track the CSI 300 since 2010. She cites desirable A-shares companies such as SAIC Motor Corp., China’s largest automaker; the Liaoning Chengda Co., its largest textile producer; and the Qinghai Salt Lake Potash Co., the country’s largest producer of potash.
“PEK’s prospectus has allowed for an RQFII subadviser for some time, so we are excited that the Chinese market has finally opened up,” says Bagaria. “In terms of timing, all I can say is, ‘Soon.’”
“China is working to allow more direct access. [The Chinese] realize they need more investment,” said Martin Kremenstein, CEO and chief investment officer at DB Commodity Services, in a webcast that first aired October 7. Foreign investment is now less than 1 percent, and the Chinese, he said, “want to get to around 13 percent.” And with the latest round of reforms in China, a number of industries stand to benefit from more private capital, noted Lin Li, China strategist and economist for Deutsche Bank in Hong Kong on the same webcast: health care, clean energy, construction, even baby products, which will benefit from the coming relaxation of China’s one-child policy, she said.
Meanwhile, a number of other emerging markets are beginning to open up to institutional investors. “The Russians are taking some steps to make it more appealing to buy stocks trading in Russia,” says Jeremy Schwartz, director of research at ETF provider WisdomTree in New York, rather than through global depositary receipts (GDRs), which trade in London.
As of July 1, 2014, the Central Bank of Russia Capital Market Service plans to make Russia’s local shares available through Brussels–based settlement service Euroclear. Alexey Zabotkin, head of investment strategy at VTB Capital in London, predicts that “this will make global investors more indifferent when choosing between GDRs and local shares.” Once clearing and settlement through Euroclear kicks in, any disputes will be governed by the laws of the investors’ jurisdictions. For the moment, any disagreements over Russian local shares have to go to court in Russia, and, says Zabotkin, “for most international investors, this is an undesirable complication.”
Approximately half of the daily volume in Russian companies trades outside the country, notes Mathew Lystra, senior index research analyst at Russell Investments in Seattle. “Russia is certainly doing what it can to pull that back into Russia itself,” he says, noting that over “the last 12 to 16 months in particular,” the Russians have adopted a number of regulatory and infrastructure reforms to try to bring their market, renamed the Moscow Exchange after Russia’s two stock exchanges merged in late 2011, in line with global standards. “Whether or not that happens will be reflected in the trading environment there in the next three to five years,” he says.
But, says Gustavo Galindo, a New York–based portfolio manager at the $4 billion in assets Russell Emerging Markets Fund, the issue of whether emerging or frontier markets are open or closed to foreign investment is “not necessarily black or white; there are different degrees, and shades of gray, as to how open or closed they are. India is supposedly open, but that’s a difficult one, because you will have to wait potentially for years,” and, he adds, “the regulations are so steep.” Thailand is a “little more open” than India because it has established three share classes: local, foreign and nonvoting depositary receipts. So, if the foreign allocation is oversubscribed, foreign investors can still buy the nonvoting depositary receipts.
“There are other select examples of this type of option around the world, like Fuji Media Holdings from Japan,” says Lystra. “Media companies often have a foreign ownership limit applied,” he adds, which is 20 percent for Fuji. “But additional shares can be purchased without voting rights,” he notes. “Any market in the world where there are attractive natural resources –- oil in the Middle East, fish in Iceland, mining in Australia –- you’re going to have a high likelihood that much or all of their shares will be restricted. It’s something we observe worldwide,” Lystra says.
And, he adds, forget about Argentina, Bolivia and Venezuela. “We’ve seen those markets regress in levels of access” because of anticapitalist sentiment. Argentina is a well-developed economy with a sizable GDP, but it “continues to push a pretty hard-line stance against foreign investment” (see also “Why Argentina Is Eager to Settle Its Financial Dispute with Repsol”).
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