Morgan Stanley and iShares: Two China A-Share ETFs

Includes: CAF, IFXAF
by: Siwei Zhong

As of yesterday there are now two ETFs with a pure focus on the China A-share market. They are Morgan Stanley China A Share Fund (NYSE:CAF) and iShares FTSE/Xinhua A50 China Tracker (OTC:IFXAF) (or 2823.HK).

Below is a comparison of these two ETFs and my personal preference based on the latest development of the Chinese government policy.

Listing Location

CAF is US listed closed-end fund denominated in US$; iShares FTSE/Xinhua A50 China Tracker is HK listed denominated in HK$ (2823.HK) and is traded on the pink sheets in the US (OTC:IFXAF).

Index Fund/ Actively Managed Fund

IFXAF is a passive index tracking fund. The Fund's objective is to track the performance of the FTSE/Xinhua China A50 Index. The Fund invests in Chinese A-Shares Access Product [CAAPs] issued by a connected person of QFII as underlying investments.

CAF is actively managed and invests directly in Chinese A-share with its allocated QFII (Qualified Foreign Institutional Investor) quota. Its fund manager is supposed to exercise his strategy to pick stocks that will beat the index.

Fund NAV (as of 14 March 2007)

IFXAF: HK$18.1B (or US$2.3B)

CAF: US$421M

Top 10 Holdings (as of latest report)


Out of its top-10, 19% of the fund is invested in the bank/finance sector.



Out of its top-10, 28.2% of the fund is invested in the bank/finance sector.


Sector Breakdown





We can see that CAF overweighted in the industrial sector while the A50 index is more banking and finance biased.

Discount/Premium (as of last closing)

IFXAF: 7.16% discount to NAV

CAF: 12.44% discount to NAV

You can check out the most recent discount/premiums for CAF here and IFXAF here.

After reading all the factual information, here is my further analysis based on the current Chinese political and economical situation.

I am very bullish towards China’s general economic and stock market growth, at least towards the end of 2008 when the first Olympics is being hosted by China. ‘Face’ is one of the main reasons why China would support the market till then. Secondly, the CSRC (China Securities Regulatory Commission) has already announced the plan to accept HK listed Red Chips to 'return home' and list as A-share in Shanghai Stock Exchange. In fact, according to news source from China, China Mobile (NYSE:CHL) has already submitted such an application this week. This is in addition to the H-shares 'returning home', which has already started and will see more on an ongoing basis. China Life (CHL) is one of the H-shares that just 'returned home' recently.

What is the implication of the ‘return home’ of Hong Kong listed Chinese stocks? As in any market index, the criteria of selecting constituent stocks is to pick the most representative companies in each sector with high trading liquidity. In the past there were very few such companies listed in Shanghai/Shenzhen, not because those companies didn’t exist, but because they have chosen to list overseas (mainly in Hong Kong) due to the previously underdeveloped stock market in China. Now those 'return home' companies will undeniably become a strong catalyst to the Chinese stock market because investors are more willing to re-allocate their money from low interest saving accounts to a stock market now filled with profitable industry leading giants.

At the same time, those original A-50 smaller constituents' less profitable companies will be kicked out from the index. This process will go on until there are no more companies need to be reshuffled from the index. This will take at least a few years and is exactly a period during which the A-50 will experience the highest growth rate.

So the next question is whether CAF can beat the A-50 index?

I previously did not have preference among the two, until CAF disclosed its full portfolio recently. I reviewed the latest CAF annual report and its full portfolio. I am not too pleased with what I see.

CAF has invested around 5% of its money into 11 funds (including the iShare A-50 fund!). I really cannot understand the reason for doing so when there are a whole lot of available alternative companies in the Chinese market. So practically 5% of CAF is a Fund of Funds. This raises the question of whether the CAF manager has really tried his best to increase the return; it may be a sign of agency problems. Though 5% of the NAV is not a significant amount, I always believe that minor issues can help us to uncover bigger truths.

CAF investment in other Funds


There are many research papers which show that the most active funds cannot beat the index. Unless there are strong evidences to convince me that an actively managed fund is better than the comparable index fund, I would rather play it safe, especially in this case when the A-50 index is so rosy. I am in favor of iShares FTSE/Xinhua A50 China Tracker (IFXAF.PK or 2823.HK).

Disclosure: Author has a long position in 2823.HK (OTC:IFXAF)