Five Most Interesting Asian ETF and Indexing Stories Currently Playing Out

Burton Malkiel has been talking about China for the last few years. Now I think I really get it.

I have been in Hong Kong this week, speaking at and chairing the IQPC indexing conference here. There are so many intriguing story lines in Asia, particularly around China and the emerging Asian economies. The plot seems thicker than the inner palace workings of a Roman emperor's court, and it's happening on a macroeconomic and political scale that is changing the course of world history.

There cannot be any place more exciting or intriguing to be in the world right now. While we're on our Top 5 or 10 lists, why don't I put one together right here to help organize my thoughts around China, because my head is spinning. And it's not just the time zone difference and absurd work schedule I've been on.

Top 5 most interesting stories in Asia around ETFs and Indexing

5. The Asian ETF market has not taken off.

What's going on here? From early years (I remember when the Hong Kong TRAKRs was the world's largest ETF), Asia had its foot in the door. But somehow, the Asian ETF market, for all the trading and equity culture here, has never really taken off. And where there IS a huge concentration of ETF assets (in Japan), that's just money parked there by the biggest Japanese institutions; there's no trading and no real retail interest.

The explanation for this varies from suggestions that Asian investors are not natural indexers (which I find patronizing—but who said ETF investing necessarily had to have anything to do with index investing anyway?), to not enough issuer or regulatory push to develop the ETF markets, etc. I get the feeling that it's coming, and that it will come thick and fast after Europe and with China's continued maturation as a financial market. That's why I'm here.

4. The usage of ETFs as a tool by Asian governments.

This, for those of you who don't know it, is the history of the TRAKRs. The Hong Kong government had bought up a huge amount of shares of the largest HK companies as a way to stabilize the economy, and used the ETF mechanism as a way to offload the $4 billion or so in shares.

For the first time at this event, I heard of Malaysian government plans to do the same. I had the bonus opportunity to moderate a panel including Dr. Pisit Leeahtam (who served as Deputy Minister of Finance in Thailand from Nov. 1997 through Feb. 2001, and so was right in the thick of the Asian financial crisis), and Stuart Leckie, an old hand in Hong Kong, who was a Director of the group that launched the TRAKRs and had served as Chairman of Watson Wyatt in Asia and Fidelity Investments in Asia. The point about the new plan in Malaysia was raised from the audience by Chua Kong Khai, who is "Head, Information Services" for the Bursa Malaysia.

Mr. Chua said that Malaysia had plans to similarly offload government-held shares in an ETF to the tune of around $1 billion and would soon be making an official announcement. I asked him about the crisis and how things might have been handled differently, and he made it clear that Malaysia's perception among international investors was severely damaged, and that the country is making strong efforts to shift those perceptions and to bring Malaysia back into the investable mainstream. The ETF effort is one step in that direction, and something that I find extremely interesting.

3. The question of whether we're in a boom, a bubble or a combination of both with China.

While it has tumbled back to some degree recently, the Chinese market particularly has scaled insane heights of late, at one point doubling its market cap in one 8- or 9-month stretch of 2007. Good lord. Consensus says they're due for a pullback, but that the future is wide open. There are some points of comparison similar to the "new paradigm" talk out of Japan and tech before the collapses there ... which makes me nervous. But the big picture is obvious and compelling. It's why Jim Rogers moved to Singapore and sold his place on the Upper West Side and has been teaching his offspring Mandarin for the last 5 years. It's why Burton Malkiel has gone completely gaga over China in his new book, and why the dollars have flowed in here. And it is for real.

Looking at the resources and the growth potential, this is the future in a way that Japan never could have been. There is just so much room to run in China. And running they are. India? Never been sure. Other Asian EM, sure. Africa? South America? Seems like a tough rode still.

2. The A Share, H Share question.

The coolest presentation for the inner indexing geek in me came from Vincent Kwan of the Hang Seng. Hang Seng has put together a beautifully simple little index that tracks the A Share/H Share premium/discount.

First, some background for those who don't know. A Shares are the stocks of mainland Chinese companies that, by and large, are available only to mainland Chinese (a small quota of A Shares are available to some qualified foreign investors). H Shares are the shares of mainland Chinese companies that trade on the Hong Kong exchange, and are largely available ONLY to foreign investors and not to mainland Chinese.

A very interesting development has occurred: The A Shares have been trading at a HUGE premium to the H Shares.

Here's how the Hang Seng A-H Premium Index works: The company totals up the relative values of the A Shares and divides it by the H Share values. They then multiply that by 100 to get an index number: Right now it's at about 160, meaning the A Shares are valued 60% higher than the H Shares. Many of the largest and most recognized companies trade at 2X to 3X higher valuations in mainland China. It's crazy.

The conventional wisdom among the sophisticated institutional investor from the West has been that mainland Chinese have a "casino mentality" and are irrational investors.

I think that is a patronizing and, well, kind of a simple view. To me, it's all about supply and demand. Look at how accepted valuations in the U.S. have spiraled (and dividends have shrunk) as more and more (baby boomer) investor demand for shares emerged. That is the dynamic. And don't try to tell me the bulk of that money in the U.S. is smart money, or smarter money.

Vincent Kwan was outlining how investors might capitalize on the premium (which moves with every Chinese government pronouncement that they will or will not be allowing mainland Chinese investors to get better access to H Shares). To me it's pretty simple. The possibility remains that the premium could go away overnight if markets are opened up. So: 1) it's that 60% you're looking at, and 2) presumably with free trade and the opening of the supply side to demand, the H Share valuations would move up as the A Share valuations moved down in a free market.

My question to him to see how those flows might go was, "How big is the relative float in A Shares vs. H Shares?" This is a question I had never seen addressed. The answer surprised me a bit—that is, that it varies, but, by and large, the H Shares have 2-3 times more float than the A Shares. And obviously there's a bit of squeeze on the A Share side.

So thinking through that, it's clear to me that you're not going to just get that 60%, and that a good deal of the give could happen on the A shares side downward. Anyway, fun stuff, and I'm sure all you index arb guys are all over that project.

1. The questions around Asian investing psychology, efficient markets and whether or not Asian EM or EM in general is legitimate indexing terrain.

This obviously works into what I've just been talking about re: the Chinese investor mentality. My point would simply be that we've seen it all before. U.S. investors drove the tech market to insane heights in a short amount of time, and Chinese investors are doing it now with some of their newfound wealth. And if there were really something to all that tech stuff (which there was), there's even more to the macro story around China. It's all relative, and everyone always thinks they're smarter than everyone else ... you know, Lake Wobegon-style, where everyone is better than average. In response to my question during the A Share/H Share presentation, Vincent Kwan asked the audience whether they thought that A Share or H Share valuation was more rational. And in a crowd of 75 to 100, one hand went up for A Shares (and it wasn't mine). He'd asked the same question in mainland China a week or two before and I'll give you one guess on what the breakdown of raised hands looked like. (It was 50/50, he said, guessing that about half the audience were international investors from outside of the mainland.)

Written by Jim Wiandt

Comments

[huangjin]

I've never seen anything but technical analysis on Chinese television and in Chinese newspapers, although one can find plenty of books on or by people like Buffett and Lynch.

[jag]

The world's second largest country and third largest economy, with a growth story that is at least as fundamental as China's, is dismissed with a brief "Never been sure"? I for one see a much more optimistic long term story for India due to its inherently more functional and stable form of governance - when I choose to invest my money between capitalist authoritarianism and capitalist democracy, the latter seems like the sounder long term bet.