By Ashley Lau

U.S. asset managers are eagerly expanding into China's stock market by launching exchange-traded funds that invest in the country's locally listed equities, hoping to cash in on the early success of the first of such U.S.-listed ETFs.

Issuers Deutsche Asset and Wealth Management and Van Eck Global are among those adding funds after seeing their own initial forays into the market quickly attract assets. China cleared the way for these new funds when it dramatically expanded foreign access to its markets in March 2013.

The new funds focus on areas such as consumer staples, consumer discretionary products and small-company stocks that analysts expect to do well even as the broader market has been hit hard in recent weeks.

"Those are the areas that look most interesting in China" as the country's leaders continue looking to consumers to lead economic growth, said senior ETF.com analyst Dennis Hudachek, who specialises in the region and has been closely following the market.

The edge these new ETFs offer U.S.-based investors is direct access to China's so-called A-shares, the renminbi-denominated shares of companies incorporated in mainland China and traded on the Shanghai and Shenzhen exchanges. Previously, ETFs investing in the A-shares market were only able to do so through swaps, futures contracts or other derivatives.

Deutsche Asset and Wealth Management introduced the first of such ETFs in the U.S. market, the db X-trackers Harvest CSI 300 China A-Shares Fund, in November 2013; since then the fund has more than doubled in size, reaching $222 million in assets in January, despite being down 11.7 percent from its first day of trading. Now the firm plans to introduce another group of such ETFs, according to regulatory filings that show at least nine funds in the works.

Van Eck Global's Market Vectors ChinaAMC A-Share ETF, which had been investing in the Chinese A-shares market via swaps, converted to direct A-shares in January and now has $33.2 million in assets. It has filed with the U.S. Securities and Exchange Commission for at least five more ETFs that would offer access to the mainland China market. A third entrant, the boutique China-focused asset management firm KraneShares, just rolled out its first A-shares ETF earlier this month and has already filed for a second.

Though both Deutsche and Van Eck's ETFs have been hurt in recent weeks as the broader Chinese market sold off, ETF analysts and issuers remain positive on the long-term picture for China and the A-shares market. In the last month, Deutsche's ASHR ETF fell 7.9 percent and the Market Vectors fund is down 7.8 percent.

"A-shares are going to become more and more important for investors in Chinese equities," said Martin Kremenstein, head of U.S. ETFs for Deutsche Asset and Wealth Management, a division of Deutsche Bank AG. "In terms of where the real exposure is to the Chinese economy, A-shares are it."

Issuers also note that these funds may allow investors to get into China A-shares ahead of investors in ETFs tracking broader benchmark indexes, which may also be adding the shares as major index providers look to include them in their benchmark indexes.

A-share listings, which accounted for nearly $3.6 trillion in total market capitalisation on the Shenzhen and Shanghai exchanges as of last March, have risen by 75 percent over the past decade, according to FTSE data. Other Chinese share classes include B-shares - similar to A-shares, though not quoted in renminbi - as well as H-shares traded in Hong Kong, red and p chips incorporated outside of mainland China, and N-shares listed on U.S. exchanges.

"Expectations that there will be a lot of money flowing into this market is going to be on investors' minds for quite some time," Hudachek said.

Restrictions ease, money pours in

U.S. ETF providers have only been able to enter the direct A-shares market through a new program started in 2011, which allowed them to get shares through partnerships with qualified asset managers. But that program, called the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme, required them to purchase shares through a small pool of partners in Hong Kong and sharply restricted the amount of shares available.

Chinese regulators expanded the program last March and increased the total amount available for the program - what they term the program quota - roughly 13-fold, to $43.5 billion.

Investors have been piling in. Foreign investors, most from the United States, have bought up $29.4 billion of that quota, up roughly 7 percent since the end of 2013.

"That's grown exponentially - not only the quota amount, but also how many asset managers and investors have access," said Jamie Perrett, director of index research at FTSE.

U.S. ETF providers still need to partner with a qualified firm in Hong Kong, Taiwan, London or Singapore to be able to include A-shares in their ETFs. There were 56 qualified RQFII firms as of November 2013, up from just 12 in October 2012, according to data from the China Securities Regulatory Commission.

The partnerships are a crucial part of bringing A-share ETFs to the U.S. market. U.S. ETF providers have the largest share of the market with some $1.7 trillion in assets. The idea is that they can leverage their wide distribution network in the United States while Hong Kong asset managers can provide firsthand knowledge of the local Chinese markets and facilitate direct quota access to A-shares, said Curtis Tai, manager at China Asset Management Co, which provides the A-shares quota for Market Vectors' PEK fund.

In addition to filings from Deutsche and Van Eck, European ETF provider Source has plans to list an A-share ETF in partnership with Exchange Traded Concepts and Hong Kong-based CSOP Asset Management Ltd. The ETF would track the FTSE China A50 Index, according to a January filing.

Broader index issuers take note

Major global index providers also are adding A-shares to their benchmark indexes. MSCI announced last week that it plans to add them to its emerging markets index as early as May 2015, and FTSE figures to do a semi-annual update of its country classification matrix at the end of March. Any country classification changes will be announced in September, FTSE said.

Incorporating China A-shares into broad benchmark indexes tracked by a number of large funds could significantly boost the amount of money flowing into the A-share market, Hudachek said.

"We're giving investors the ability to invest ahead of some of those index changes that could come in the future," said Brendan Ahern, whose New York-based firm KraneShares, focused specifically on creating China-focused ETFs, just introduced its own Bosera MSCI China A Share ETF in March.

If MSCI were to include A-shares in its benchmark emerging-markets index today, it would raise China's allocation to some 30 percent, from roughly 18 percent currently, Ahern estimates.

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