ETFs are coming to China with a vengeance

A British colony from 1840 to 1997, Hong Kong grew into an international financial center just off the coast of mainland China. A Stock Connect was introduced in 2014, followed by other schemes that more closely tie the Hong Kong market to that of the mainland.

Anthony Kwan | Bloomberg | Getty Images

BEIJING — China has joined the global craze for exchange-traded funds, the investment product that allows traders to buy and sell a basket of stocks.

The funds, better known as ETFs, rose in popularity in the US after the financial crisis, building $3 trillion companies like BlackRock’s ETF brand iShares.

In mainland China, ETFs have multiplied faster than the stock market. In five years, the number of ETFs has more than quadrupled to 645, while the number of stocks has grown just 53% to 4,615.

That’s according to official data and a report by Hong Kong Exchanges and Clearing, which also noted that the mainland ETF market has become a 1.4 trillion yuan ($209 billion) deal, which translates into has more than tripled in just five years.

A regulatory change that went into effect on Monday opened up this ETF market to foreign investors via Hong Kong – a program called ETF Connect.

Beijing-based ChinaAMC, which says it launched the first mainland ETF in 2004, has seen the industry boom and operates 10 of the funds eligible for trading under the new cross-border trading program. These include ETFs that track indices and themes like semiconductor development.

The ETF Connect leans heavily towards the mainland. 83 of the first eligible ETFs are listed on the mainland, compared to just four in Hong Kong.

Goldman Sachs forecasts $80 billion more asset purchases in the mainland than in Hong Kong over the next 10 years.

“Adding northbound ETFs to the A-share portfolio could potentially expand the efficient frontier and improve risk/reward tradeoffs,” analysts at Goldman Sachs wrote in a report this week. “While the initial Southbound-eligible universe appears narrow, the underlying constituents still offer mainland investors broad exposure to Hong Kong-listed internet and financial stocks.”

Chinese internet tech giants like Tencent and Alibaba have listings in Hong Kong but not on the mainland. On the other hand, many China-focused companies are only listed on the mainland.

One of the things ETF Connect can do is promote international investors’ understanding of mainland China ETFs and increase the impact of the products, Xu Meng, a ChinaAMC fund manager, said in a statement. Xu is also Executive General Manager of the firm’s quantitative investment division.

ChinaAMC claims it had more than 300 billion yuan in passively managed assets as of the end of 2021.

New connections to mainland China

On the same day that ETF Connect was launched, Chinese regulators announced a new scheme – due to come into effect in about six months – that would allow investments in financial derivatives on the mainland via Hong Kong.

A subsequent phase of the program will allow mainland investors to trade financial derivatives in Hong Kong.

These moves to link Hong Kong and mainland markets follow similar equity and bond programs that began in 2014. Mainland China is home to the second largest stock market in the world by value.

Other ETFs will follow

Other financial firms are entering the ETF market — with a focus on Greater China clients looking to invest internationally through Hong Kong.

Shanghai-based wealth manager Hywin Holdings with a Hong Kong subsidiary launched a healthcare stock index last week with FactSet, a financial data and software company.

Consisting of 40 stocks, the “FactSet Hywin Global Health Care Index” tracks stocks of companies that are primarily listed in Europe or North America – such as AstraZeneca and Merck.

There are plans to commercialize this index with a Hong Kong-listed ETF.

Read more about China from CNBC Pro

“Hywin’s customers [more than 130,000 across Asia], increasingly they find the world very fluid, very volatile. They want to capitalize on opportunities but are less confident about stock selection and timing these days,” said Nick Xiao, Hywin Holdings’ vice president and CEO of the company’s international operations, Hywin International.

After this first co-branded index, Xiao expects to work more closely with FactSet to create indices and ETFs. He noted that there are already eight ETFs listed in Hong Kong that track FactSet indices.

Among institutional investors and money managers in Greater China, nearly 40% said they had more than half of their assets under management in ETFs, far ahead of the 19% share in the US, Brown Brothers Harriman found in an annual published in January survey out.