ETF products to spark innovation
By Mo Fan and Su Yufeng (China Business Weekly)
Updated: 2004-07-19 11:20

As China's capital market continues leaping forward, the nation's first Exchange Traded Fund (ETF) product is taking off.

Shanghai's stock exchange has authorized China Asset Management Co Ltd (China AMC) to develop China's first ETF. It will be based on the Shanghai 50 index.

An ETF is a type of investment designed to achieve the same returns as a particular market index. An ETF is composed of index-based products that enable investors to buy or sell shares of an entire benchmark portfolio.

New fund: Investors look at an index board at a local securities house in Shanghai. Shanghai's stock exchange has authorized China Asset Management Co Ltd (China AMC)to develop China's first Exchange Traded Fund (ETF). The debut of ETF product is expected to spark innovation in China's capital markets. [newsphoto]

"The birth of the ETF marks a milestone in China's capital market," said Wen Tian, an ETF expert with Shanghai-based Hua'an Fund Management Co Ltd.

An ETF is similar to an index fund. It is invested primarily in the securities of companies that are included in a selected market index. An ETF will be invested in either all of the securities or a representative sample of the securities included in the index.

For example, one type of ETF, known as Spiders, or SPDRs, is invested in all of the stocks contained in the Standard & Poor's 500 Composite Stock Price Index.

By owning an ETF, an investor gains the diversity of an index fund and the ability to sell short, buy on margin and purchase as few as one share.

Worldwide assets of ETFs rose 49 per cent, to US$211 billion, last year, indicates a report by Morgan Stanley.

China AMC is collaborating with Boston-based State Street Corp in developing details of the ETF products. China AMC, which is controlled by Beijing State-owned Assets Management Co Ltd and Southwest Securities, has five closed-end and five open-end funds. And currently China AMC is launching a new large-cap select fund.

China AMC, since launching its first optimized index fund, has accumulated five years' worth of index management experience.

"We know the mechanics of the product very well, and China AMC is in a much better position than we are to fine-tune and customize the product to the local environment," said Vincent Duhamel, State Street's chief executive in Asia.

Shanghai Stock Exchange's decision to authorize China AMC to develop the ETF products creates a solid foundation for the products' future development, Fan Yonghong, China AMC president, said.

With the support and guidance of the China Securities Regulatory Commission (CSRC) and Shanghai Stock Exchange, the successful offering of China's first ETF product will help ensure the diversification of securities products in China. ETFs, in turn, will be of greater interest to institutional investors, and the products will stimulate market activity.

Experts have suggested the ETF offering is not an isolated innovation, rather it is a critical link in the stock exchange's development strategy.

The ETF will boost the bourse's trading volume, and will be a platform for financial derivatives. That will leave room for index futures and options.

A report released by Shanghai Jiaotong University indicated the ETF will enhance the depth and activity of Shanghai's stock exchange.

In a mature market, securities firms bid for buyers and sellers as the ETF market makers, and spread in bidding may become the lucrative slice of the pie.

The new profit-making model is attractive to the currently gloomy industry. The securities house may take the opportunity to boost its proprietary trading business.

For investors, the advantage of a new financial product is the low cost of most ETFs compared with mutual funds.

Investors can easily access the ETF product, Wen told China Business Weekly.

Unlike index funds, an ETF is traded in different markets, first in the primary market, then by listing in the secondary market. This offers both flexible trading models and arbitrage opportunities for institutional investors when the two markets move inconsistently.

With the growth of China's domestic capital market, the concepts of portfolio investment and negative investment have become mainstream. Hence, as an innovative investment tool, an ETF would act as a useful vehicle for China's fledgling fund management industry.

Short-selling, which is currently prohibited in China, is another benefit of the ETF.

Selling short is the selling of a borrowed stock in the hopes the stock price will fall so an equal number of shares can be bought later at a lower price.

ETF's real prospects are less than rosy over the short term. As the management fee is comparatively low, and the ETF market is in its infancy, the profit margin of an ETF is limited.

Yet, fund management companies are allocating many resources to the ETF in the hopes of snatching the limited stock index resources. The stock index currently describes the market trend, much of which cannot be applied to ETF's development.

Hua'an and Guotai Asset Management Co Ltd have steadily advanced ETF research in recent years.

On July 12, Hua'an announced it had received permission to develop the ETF product, based on Shanghai 180 Index, from Shanghai's stock exchange.

The birth of the China-style ETF may be the bonanza investment firms, and the government, have been looking for. "A potential beneficiary of the ETF may be the government," said an expert, who refused to be named.

She said she believed the ETF will play a critical role in the disposal of both corporate shares and State shares. The ETF may become the new vehicle for selling corporate shares and State shares to domestic investors. Previously, rumours about the selling of State shares caused the market to slump.

In the short term, the ETF will be aimed at listed shares, not unlisted shares, one expert said. In future, however, the ETF could be used to dispose of State shares.

Hong Kong's government has used ETFs to privatize securities holdings.

Five years ago, Hong Kong's government established the Tracker Fund to dispose of shares bought by the government to defend against international speculators during the 1997-98 financial crisis.

Shenzhen's stock exchange is enhancing its research on LOF (listed open-end fund), which is derived from the ETF. The LOF is expected to be listed on Shenzhen's bourse next month.

[The authors, Mo Fan and Su Yufeng, are industry observers]

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