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ETF News And Commentary

Although the Chinese economy is apparently slowing down—to a rate of ‘just’ 8.9% in the most recent release—some investors remain relatively bullish on the economy. These investors point to the country’s massive reserves and still small consumer economy as two areas which, if unlocked, should help the country avoid a hard landing in the near term. Yet given the huge risks to the Chinese property market, and worries over more spending which could stoke inflation, reservations over Chinese stocks could keep many out of the space for the time being.

In light of these trends, some who are still looking to gain exposure to the Chinese market but are looking to avoid equities could be better served by taking a closer look at the Chinese bond market instead. While the Chinese bond market remains closed off to most foreign investors, what is known as the ‘Dim Sum’ market—securities that trade in Hong Kong and are denominated in yuan—is open to Western investors (also read Forget FXI: Try These China ETFs Instead).

In addition to providing greater transparency by trading out of Hong Kong, this market could also give investors a number of other advantages for their portfolios. First, and most importantly, these securities could offer up exposure to China but with lower levels of risk, a huge selling point given the uncertain near term outlook for the country. Additionally, while Chinese stocks have developed high correlations with other emerging markets and even developed markets, the China bond market has not. This is largely due to the small size of the Dim Sum segment and the fact that major institutional investors are unable to dominate the space at this time. Lastly, since the products are denominated in yuan, these products could also offer up an easy way for investors to play a rising Chinese currency or to diversify out of dollars in the bond space (see Five ETFs To Buy In 2012).

While buying individual securities is still pretty hard in this sector, investors now have three China bond ETFs available for purchase. All three of these funds have debuted in the past year and look to track similar indexes that cover fixed income securities in this market. However, while many of the securities are similar and all track Dim Sum bonds, there are several key differences that investors should be aware of. Below, we briefly outline these three funds and highlight some of the variations between the products in the China bond ETF market:

PowerShares Chinese Yuan Dim Sum Bond Fund

This ETF looks to follow the Citigroup Dim Sum Bond Index which includes a variety of bonds from a number of sources including; governments, agencies, supranationals, and corporations. The bonds included are generally fixed rate securities and have a minimum maturity of one year and a minimum size outstanding of one billion yuan. Currently, the portfolio consists of 35 securities and the fund charges investors 45 basis points a year in fees (see Go Local With Emerging Market Bond ETFs).

In terms of individual holdings, the fund is pretty spread out with all securities in the top ten receiving at least 2.7% of assets. However, the top holding, which goes to Chinese government bonds due in 2016, receives a 10.6% weighting, roughly equal to the rest of the top five combined. Investors should also note that roughly 40% of the fund is rated at least ‘A’ by S&P while another 44% isn’t rated at all. This suggests that although the fund may have a tilt towards quality securities, there is decent exposure to the unknown as well. Thanks in part to this, DSUM pays out a 30 Day SEC Yield of 4.5%, a level that is pretty good considering the effective duration is below 2.9 years.

Market Vectors Renminbi Bond Fund

The newest entrant in the space is from Van Eck with its CHLC, a fund that tracks the Market Vectors Renminbi Bond Index. This benchmark looks to give exposure to Chinese Renminbi-denominated bonds that are investable to market participants outside of Mainland China. This focus gives a fund that holds 27 securities in total and charges a rock-bottom expense ratio of just 39 basis points a year (after fee waivers of 11 basis points a year).

CHLC’s holdings appear to have a more global tilt than some of its peers in the space as just 62% of the securities are from Mainland China. The rest are divided up among a number of developed markets which have firms that are looking to issue bonds in yuan including those from Hong Kong, U.S., Germany, and Singapore. Top individual issues include Germany’s Bosch, Bank of Commerce from China, HKCG Finance, and America’s Caterpillar Financial Services Group to round out the top four (read Time To Get Regional With Bond ETFs).

With this international focus, the fund finds itself in the middle of its counterparts in terms of a number of statistics including yield as CHLC pays out 2.5% in 30 Day SEC Yield terms. However, with the fund’s heavy focus on lower risk securities and the large weightings to foreign companies, the product may not be the best proxy for Chinese bonds but could be a lower volatility play on the Dim Sum market.

Guggenheim Yuan Bond ETF

The third ETF targeting the space is from Guggenheim which tracks a ruled-based index called the AlphaShares China Yuan Bond Index. This benchmark includes bonds denominated in Chinese yuan regardless of who issued them—be it Chinese or non-Chinese issuers—and that are traded in the secondary market. This produces a fund with roughly 20 securities in total that charges 65 basis points a year in fees (read Do You Need A Floating Rate Bond ETF?).

For holdings, RMB is pretty skewed towards its top three holdings which constitute 51.3% of the total. Of these top holdings, two are lower risk quasi-government bonds from China as the China Development Bank and the Export Import Bank of China take up spots two and three, respectively. This leaves the biggest chunk in Chinese renminbi—the currency of the country—to make up over one-third of total assets. Obviously, this produces a heavily concentrated, but lower risk, holdings profile than some of its peers in the space, but it also gives the fund a dividend of about 1% and a duration of just 1.9 years.

 

Category

DSUM

CHLC

RMB

Total holdings

35

27

20

Yield

4.5%

2.5%

1.0%

Duration  (years)

2.9

2.4

1.9

AUM (millions)

$5.9

$5.1

$5.0

Rated AA (S&P)

24%

37% (AA & AAA)

30% (AA-)

Expenses

0.45%

0.39%

0.65%

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