US sanctions against a number of Chinese companies have caused problems for some of their stock listings and exchange traded funds (ETFs) that contain them.

Institutional investors with these passive products in their portfolio may have to keep a closer eye on their investments, but some experts believe that the longer-term impact is not likely to be major, and indeed some argue this is a good opportunity to buy some Chinese equity assets at a relatively low price.

Jackie Choy, Morningstar

US president Donald Trump issued an executive order on November 12 prohibiting US investment in 31 previously identified 'Communist Chinese military companies' which he deemed to be affiliated with the country's armed forces.

“The impact of the latest US ban on some Chinese stocks differs from ETF products. We believe that the impact will be relatively small and that the market will not see a dramatic capital in/outflow of these products across the region,” Jackie Choy, director of ETF research for Asia at Morningstar, told AsianInvestor.

Choy added that the availability of China-domiciled ETF products for foreign investors is still limited by the channels open to them and that they will need to do a decent amount of homework when investing into a basket of assets.

In terms of tracked assets, China-based ETF products are domestic-focused. This means that more product diversification will be needed before they are on the same playing field as other mature markets, he explained.

Globally, ETFs have an AUM of $6.3 trillion, according to a BBH Global ETF Investor survey published in January last year. The market is still dominated by the US ($4.4 trillion in assets) and is followed by Europe (with $1 trillion). Greater China still lags at $177 billion.

A CASE STUDY

Ronald Chan, Manulife IM

Trump's executive order, which had 60 days to take effect, has had an immediate impact on international issuers of ETFs.

Some passive funds domiciled outside the US but managed by US-based asset managers, including BlackRock (iShares) and State Street Global Advisors (SSGA), announced that they would not make any new investments in the sanctioned companies effective January 11.

However, a few days afterwards SSGA made a U-turn, announcing on January 13 that it would resume investments in US-sanctioned firms from January 14. The US fund manager manages Hong Kong’s largest ETF fund (TraHK) with a market cap of HK$105 billion ($13.5 billion). TraHK has Chinese companies including Tencent, Ping An Insurance, Meituan Dianping, Xiaomi and Alibaba as its top holdings.

“There was selling in some of the banned stocks, but money from mainland China, via the Shanghai-Hong Kong stock connect scheme, has been buying these shares back,” Ronald Chan, chief investment officer of equities for Asia (ex-Japan) at Manulife Investment Management, told AsianInvestor. He believes that some of the stocks are currently mispriced, which offers buying opportunities for some investors.

According to Hong Kong Stock Exchange statistics, there was heavy trading in some of the banned stocks on January 14. China Mobile and China Telecom – both on the banned list – saw HK$1.5 billion and HK$382 million-worth of demand, respectively.

Some US fund managers, including Vanguard, BlackRock and Goldman Sachs, have already started to sell down their stakes in the companies included in the ban.

CHINA ETF POTENTIAL

Chris Pigott, BBH

In Asia, demand for ETFs is increasing as more and more investors value the structural benefits of the ETF wrapper which includes liquidity and transparency, compared to active mutual funds. 

Chris Pigott, head of Hong Kong ETF services at Brown Brothers Harriman, told AsianInvestor that it has been a positive 12 months for global ETF investment. He cited the BBH Global ETF Investor Survey,* which revealed that over 80% of institutional investors in mainland China and close to 60% of those in Hong Kong had considered increasing their ETF exposure over the past year.

“Growing interest in these markets is driven by overall market attractiveness and product innovation,” he explained.

Another report published by JP Morgan Asset Management** in January also highlighted the potential of China's ETF market. While the number of [Chinese] domestic ETF products is small when compared with overseas ETF markets, and product diversity is currently insufficient, the report noted that there is greater demand for products and the willingness to allocate to ETFs has increased too.

*The BBH survey polled 300 institutional investors, financial advisers and fund managers (100 in the US, 100 in Europe and 100 in Greater China).

**JP Morgan Asset Management’s report surveyed 350 institutional investors globally.