Here Come the Chinese ETF Investors

Caijing reports that the Chinese government has allowed two fund companies to list overseas funds. China Asset Management plans a fund to track the Hang Seng Index, while Penghua Fun Management plans ETFs, with licenses for the MSCI U.S., MSCI Emerging Markets and MSCI EAFE indices.

These new funds could begin trading next year, but don't expect too much of a boost to global markets at first, because they will be managed under the Qualified Domestic Institutional Investor program that will limit the amount of capital allowed to flow outside the country.

Capital restrictions could cause the ETFs to trade at a premium and would provide a gauge of Chinese demand for foreign assets. Some economists have speculated that the Chinese yuan would weaken if it were floated now, because of this pent-up demand. It's speculation at this point, but a premium on ETFs of foreign shares could provide at least some quantification of that demand.

China will move very slowly to open its capital markets, but once money begins moving out, the government can balance it with foreign money flowing into the Shanghai and Shenzhen markets, raising the larger issue of the development of China's economy and the convertibility of the yuan.

I still believe investors can best play China's development via the more volatile Claymore/AlphaShares China Small Cap (HAO - commentary - Trade Now), which mainly invests in Hong Kong listed H-shares. iShares FTSE/Xinhua China 25 (FXI - commentary - Trade Now) has 47% of its assets in the financial sector, but these are mainly the state-owned behemoths. Since this will play out over many years, my hunch is that by the time the financial sector is ready to bloom, there will be a better option for investors, perhaps by that time even sector ETFs.

The most direct way to play the ETF development would be iShares Hong Kong (EWH - commentary - Trade Now), or better yet, for investors with international access, the Hong Kong-listed Hang Seng Index ETF (symbol 2833), though I would wait until we know the amount of capital allowed under the plan, because it may not be sufficient to generate a share rally in Hong Kong.

Another reason investors should wait is that China's government considered slightly loosening investment restrictions to allow mainland investors access to Hong Kong stocks back in 2007, but the market peaked and plans were shelved -- partially because of fears of capital flight.

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At the time of publication, Dion had no positions in stocks mentioned.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.