Invesco launches swap-backed China ETFs
Invesco has launched Chinese plain vanilla equity ETFs that invest in large and medium-sized Chinese companies. The funds are listed on the London Stock Exchange, Deutsche Boerse, Borsa Italiana and SIX Swiss Exchange.
Unusually, the funds track indexes from S&P Global. They do not use the official Chinese share market gauges from CSI, China’s main index provider.
C300 tracks the S&P index that comprises 300 of the largest A-Shares on the Shanghai and Shenzhen exchanges. While C500 tracks the next largest 500.
The indexes exclude companies on the United States’ Office of Foreign Assets Control Sanctions list. Under Biden, the US has built out an expanded list of sanctioned companies, all of which still feature in the official CSI 300 index.
The funds use swaps provided by London investment banks to track their indexes. They do not buy A-Shares directly. The investment banks provide this service for a fee, which I cannot find disclosed in Invesco’s product literature.
The stated management fee is 0.35%.
Bernie’s commentary – why synthetic?
The main question I had when looking at this launch is why Invesco went for synthetic replication. For US equities, synthetic ETFs are tax advantaged and outperform. This is because the US government doesn’t apply its dividend tax on synthetic ETFs like it does for physical ones. Invesco has been one of the foremost champions of synthetic ETFs, and I personally use their S&P 500 ETF.
However, these dividend advantages aren’t true for China to my knowledge. So what’s the appeal? In explaining why they chose synthetic, Chris Mellor, Invesco’s ETF product boss, said:
“The dynamic of China’s onshore equity market can offer a structural advantage for synthetic replication. Quant desks and hedge funds running market-neutral strategies do not have access to traditional methods for hedging the market risk, so they often use index derivatives written by banks. The ETFs may sometimes benefit from favourable conditions in the swap markets, although the potential outperformance of the index will fluctuate and is not guaranteed.”
I struggled to see a clear advantage spelled out here. So I asked some people who know more than me. The people I asked said that synthetic ETFs on China can still enjoy slight tax advantages as the fund doesn’t have to buy and sell securities. When physical ETFs buy and sell shares, they can generate taxable events. If you compare the performance of CSOP’s synthetic and physical China A50 ETFs in Hong Kong (2822, 2823), we can see that the synthetic one has very slightly outperformed. So maybe that’s the reason.
I’m sure there is more to it than this. It would be interesting to get Invesco’s thoughts here.