E Fund Management was selected by authorities as one of the first three managers to offer physically replicated exchange-traded funds (ETFs) tracking equities in China’s A-share market.

It is one of the three largest managers in the country by AUM with $33 billion as at June this year, and it has been rated one of the best fund managers by industry data provider Morningstar.

It won the “Golden Bull award” as best fund manager from the China Securities Journal; was ranked top in China for overall investment capabilities, performance of open-ended and closed-ended funds and is the number one index provider in the country.

Explaining the evolution of A-share ETFs, Eugene Lee, E Fund’s global head of sales and marketing, notes that investors accessing China’s stock market have typically faced hidden risks and high expense ratios.

But he argues that the launch of the ETF programme under the renminbi-denominated qualified foreign institutional investor (RQFII) scheme has changed the landscape to create a more level playing field.

This RQFII ETF programme provides investors with physical replication and renminbi settlement at a competitive cost.

The key is to understand the usage of each RQFII ETF, because each product is used for different purposes, with differences between onshore and offshore premium, and strategies such as long-short and buy-and-hold.

Each of the first three RQFII ETFs is described below.

The CSOP FTSE China A50 (82822.HK) comprises 50 large-cap stocks heavily weighted to financials and related services. It tracks the FTSE China A50 Index and has a management fee of 99 basis points.

The E FUND CSI 100 (83100.HK) comprises 100 stocks focused on “core blue chips” on the Shanghai and Shenzhen exchanges. The idea is to have the best of both growth and large caps. Their focus ranges from financial-related services and non-cyclical consumer stocks to industrials. Together these stocks account for 50% of total market cap of both the Shanghai and Shenzhen bourses. The ETF tracks the CSI 100 Index and has a management fee of 76bp.

China AMC CSI 300 (83188.HK) comprises 300 stocks with diversification across the A-share market. It tracks the CSI 300 Index, is traded on the Shenzhen Stock Exchange and has a management fee of 70bp. There is also a futures contract available for long-short strategies.

Counterparty risk
RQFII ETFs have exposures that are 100% physically replicated and have no counterparty nor derivatives risk embedded in their structure. This results in a low tracking error, transparency in collateral and price efficiency.

Physically replicated ETFs offer competitive pricing in management fee, while investors in these RQFII products do not have to pay stamp duty.

At present these ETFs are traded in renminbi (HK dollars if the asset manager is qualified for HK dollar listings).

Withholding capital gains tax (CGT) reserve treatment
Capital gains tax is calculated using mark-to-market. Unrealised gains are incorporated into net asset value (NAV) proportionately and the CGT will be zero if there are unrealised losses.

Liquidity and turnover
It’s the asset of the underlying that needs to be liquid. ETFs are expected to trade less frequently than stocks, and participating dealers can create and sell units even with zero turnover.