ETFs tracking China's onshore markets struggle to find an audience

By Trevor Hunnicutt

(Reuters) - The lopsided performance of exchange-traded funds tracking China's turbulent domestic markets is stanching the flow of new money into a market that once excited investors.

Investors pulled $418 million out of ETFs tracking Chinese stocks that trade on the Shanghai and Shenzhen exchanges in the year to Dec. 21, withdrawals representing more than half the total assets held in those funds, according to FactSet Research Systems Inc (NYSE: FDS).

Over the same period, ETFs tracking Chinese stocks not traded on the mainland attracted $1.2 billion.

Much of the outflows came during a late-summer rout of once-high-flying stocks that exposed issues with government intervention, corruption and strict regulations for foreign investment.

Moves by China's government to restrict trading on domestic exchanges have sometimes blocked index funds from buying the stocks they need to replicate the performance of Chinese benchmarks.

When China halted most trading on its onshore exchanges in July, for example, the largest A-Shares fund, Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (NYSE: ASHR), was thrown so far off track that its losses for the year at one point doubled the index's.

Since then, A-Shares ETFs have managed to rebound, delivering an average 0.7 percent in returns for the year to Dec 21, compared with the 2.5 percent loss averaged by other Chinese stock-tracking funds, FactSet said.

The Deutsche ASHR has also improved its performance - the value of the fund's shares traded on exchanges increased 19 percent over the 12 months that ended in November, compared with the index's 24 percent return, Deutsche data shows.

Despite the resurgent performance, lingering concerns are preventing the funds from taking off.

On Monday, the ASHR ETF paid investors $8.43 for each share held, about a quarter of what they are worth. Such so-called distributions are viewed negatively by investors, who must pay taxes on the earnings.

The distributions were likely tied to heavy redemptions by the fund's investors this year, which sometimes force the sale of stocks held by the fund, according to Todd Rosenbluth, U.S. director of ETF and mutual-fund research at S&P Capital IQ (NYSE: MHFI).

When funds sell assets that have gained value, they have to pay those earnings out to investors.

PowerShares said earlier this month that it will shut down its China A-Share Portfolio (NYSE: CHNA) in March.

Spokeswomen for Deutsche Bank AG and PowerShares owner Invesco Ltd (NYSE: IVZ) did not respond to requests for comment. In an earlier statement, PowerShares said CHNA's closure would "align its product line with the changing investment landscape."

The weak sales of ETFs tracking Chinese A-Shares come despite performance that bests their traditional counterparts. Other Chinese ETFs often track shares of companies that trade outside mainland China, in places such as Hong Kong.

One top-performing fund, Market Vectors ChinaAMC SME-ChiNext ETF (NYSE: CNXT), has returned 46 percent over the year to Dec. 28, according to Morningstar Inc (NASDAQ: MORN). The fund focuses on privately owned firms, as opposed to Chinese state-owned enterprises, in sectors such as information technology and healthcare.

"At the end of the year we're still going to see these products being the best performers," said Rosenbluth. "My fear would be investors in these products not fully understanding the risks tied to a still-emerging market."

Nonetheless, ETF companies are pushing forward with new products in the hope that China's markets will offer investors more diversified portfolios and access to quick growth in the world's second-largest economy.

A decision last month by MSCI (NYSE: MSCI) to add Chinese companies listed in the United States and elsewhere, such as Alibaba, to its indexes was also seen as improving investors' exposure to China's growth.

Vanguard Group is currently adding A-shares to its $51 billion Emerging Markets Stock Index Fund (NYSE: VWO). Deutsche is planning more A-Shares products, as are BlackRock Inc's (NYSE: BLK) iShares and other issuers, according to U.S. regulatory filings.

A Vanguard spokesman said Chinese markets have proven easy to trade in and described the fund's transition to A-Shares as going "exceptionally well."

(Reporting by Trevor Hunnicutt; Editing by Linda Stern and Dan Grebler)

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