Foreign investors often grow frustrated with China’s long and complicated applications process for qualified foreign institutional investor (QFII) licences and quotas.
But one boutique investment management firm reckons it has invented a new synthetic QFII model to replicate the onshore A-shares market, catering to foreign investors with no QFII quota.
Shanghai-based AZ Investment has developed the AZ Synthetic QFII Portfolio to replicate A-share exposure by selecting individual securities in globally listed Chinese B-shares and H-shares, which all foreign investors have access to.
Stefano Chao, AZ’s investment manager, says this synthetic portfolio, which takes into account the foreign exchange movement of the renminbi, provides “low-cost, immediate, liquid and transparent access to onshore Chinese markets without having to wait years for a QFII quota or having to pay substantial fees to third parties”.
Some offshore investors choose to rent QFII quota from licensees “charging up to 10% transaction fees for a round-trip investment”, notes Chao.
From back-testing to January 2008, the AZ synthetic portfolio is highly correlated with the CSI 300 (97.64% of price correlation) and with a low tracking error of 17.79%.
“In terms of execution, the portfolio has low frictional costs without QFII licence or rental [fees],” adds Chao.
That said, China may reform the B-share market (possibly via a merger with the A-share market), which was introduced in the mid-1990s to allow Chinese firms to raise funds in foreign currencies and for foreigners to invest in Chinese stocks. But it has since become illiquid as Chinese companies started to list overseas in 1997 and once the QFII scheme was kick-started in 2002.
Chao admits the regulatory overhang could be a potential issue, but he points out: “If the B-share market goes away one day, the portfolio construction, which is dynamically and actively managed, will adjust securities selection to account for the change.”
At this stage, whether the synthetic QFII portfolio model can be developed into a real product will depend on offshore investor interest level and demand, admits Chao.
Sau Kwan, senior vice-president and managing director at State Street, points out that foreign institutional investors are often frustrated at the lengthy and complicated application and approval process of QFII licences and quota, leading to the undesired consequence that Chinese assets are significantly underweighted in global investment portfolios.
State Street’s latest Vision Focus paper, China’s Funds Future, finds that although China currently accounts for more than 9% of global GDP and over 11% of global market capitalisation, Chinese assets still only make up 2.3% of the MSCI All Country World Index.
It also notes that actual investment in A-shares on the Shanghai Stock Exchange comprises of less than 1% of global portfolios.
As of the end of October, a total of 119 foreign financial institutions had obtained QFII licences, including 13 newcomers so far this year.