China’s somber stock market climate is prompting a surge of record-breaking proportions in investments from Chinese investors into foreign stock exchange-traded funds (ETFs). In January alone, an unprecedented $2 billion flowed into 33 onshore ETFs tracking foreign benchmarks, excluding Hong Kong, marking the largest monthly influx since Bloomberg began tracking data in late 2020. A substantial portion of these funds, exceeding half, found their way into U.S. stocks as the S&P 500 index reached new peaks, while an additional $204 million flowed into Japanese markets.
This heightened enthusiasm for foreign ETFs has created significant distortions within the domestic ETF market. Prices for some ETFs have soared to levels as much as 40% above the underlying asset value, accompanied by extreme volatility and frequent trading halts. Despite these risks, investors remain undeterred. With China’s strict capital controls, these products are highly sought after as one of the most viable channels for retail investors to access foreign markets, especially as local stocks continue their downward trend.
Peng Hong, a fund manager at Shenzhen Zhichang Fund Management Co., remarked, “Investors are making their preferences known. While chasing these funds at a premium carries risks, it’s seen as the lesser of two evils. While investing in U.S. stocks might result in losses, opting for onshore stocks could lead to deeper losses.”
This trend reflects a broader shift away from the Chinese stock market as local investors lose confidence. Global funds have been withdrawing capital for a record sixth consecutive month, pulling out another 14.5 billion yuan ($2 billion) in January alone.
Despite sporadic stock market gains driven by hopes of economic stimulus, these have been short-lived, with weak economic data quickly dampening optimism. The CSI 300 Index has plummeted to a five-year low, shedding over 7% since the beginning of the year. Furthermore, only a small fraction of companies listed in Shanghai and Shenzhen are experiencing positive performance this year.
In stark contrast, overseas markets have witnessed robust growth. Strong corporate earnings and optimism surrounding a soft landing for the U.S. economy have propelled equities to new heights, while Japanese benchmarks hover near three-decade highs as the economy emerges from deflationary pressures.
The ETFs attracting significant attention are part of China’s qualified domestic institutional investor program, allowing select fund houses to invest in foreign securities within specified quotas. However, the limited availability of quotas has led to ETF prices surging beyond the actual value of the underlying assets. Consequently, investors face the risk of a double blow if overseas markets experience sudden corrections or if the premium vanishes.
Despite efforts to temper enthusiasm, demand remains strong, particularly for new products yet to face restrictions. While premiums have moderated from extreme levels observed in January, demand persists, prompting issuers to introduce caps on daily subscriptions for certain ETFs tracking foreign stocks.
Chen Shi, a fund manager at Shanghai Jade Stone Investment Management Co., cautioned against following herd behavior, warning that chasing highs in foreign markets at such premiums could lead to potential losses. Nevertheless, with investor sentiment fragile, many continue to seek solace in these QDII investments.
