A New Era for China's Fund Market!

On November 15, 2023, the first batch of A500 Exchange-Traded Funds (ETFs) celebrated their one-month anniversary since being listed, with a total combined scale surpassing 1150 billion yuan, breaking historical records for the fastest fund to exceed 100 billion. This was further bolstered by the issuance of a second batch of funds and the launch of off-market linkage funds, pushing the overall product scale close to 2000 billion yuan. Among these, the Huaxia Fund's A500ETF (512050) was launched on the 15th, with its shares exceeding 4.8 billion, and its trading activity has been notably vibrant, placing it among the top in terms of turnover rates.

As the ETF market garners fervent interest, actively managed funds are witnessing a steady decline in size. The landscape of A-shares is transforming index investing, signaling a shift in preferences among Chinese investors.

Since the beginning of 2024, the so-called "national team," spearheaded by the Central Huijin Investment, has been actively entering the market via ETFs, leading to a continuous expansion of holdings in broad-based ETFs like the CSI 300 ETF. By the end of the third quarter, the national team's holdings in stock-type ETFs reached a total market value exceeding 940 billion yuan, representing an increase of over 800% compared to the end of 2023.

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This significant engagement has exhibited a demonstrative effect, encouraging retail investors and various types of institutions alike to enter the market through ETFs.

According to Wind's statistics, by the end of the third quarter, the passive equity fund scale in the A-share market had reached 3.36 trillion yuan, accounting for 47% of the market and reminiscent of the U.S. market levels in 2018. Moreover, the market value of passive public funds’ equity holdings was an astonishing 3.16 trillion yuan, equivalent to 8.4% of the total free-floating market value of A-shares, surpassing the 2.89 trillion yuan of the same period for active public funds.

This marks a historic ascendancy, as the scale of ETFs has ballooned 600 times over the past two decades.

Among this 3 trillion-plus total, broad-based ETFs account for an impressive 74%. Sector-specific ETFs focusing on technology, media, and telecommunications (TMT), consumer goods, healthcare, and financial real estate also exhibit significant proportions, all exceeding 5%. Within the broad-based category, products tracking the CSI 300 index have crossed the 1 trillion yuan mark, comprising roughly 50% of the total. The A500, despite being newly established, has already surpassed 115 billion yuan in scale, and has strong potential for future growth.

But what has made ETFs increasingly attractive to investors?

First, in recent years, the disappointing performances of actively managed public funds have generated widespread criticism. It has become commonplace for these funds to underperform their passive counterparts in similar categories.

According to Morningstar's statistics, by October 2024, only 20% of active funds managed to outperform their passive peers in the past year. Over a longer timeframe, more than 50% of active funds have failed to match the returns of passive funds, with some even liquidated before reaching a three-year lifespan due to underperformance.

Additionally, the high fee structure of actively managed funds contrasts sharply with that of passive funds, which has further driven investor sentiment away from the active management model. As of mid-2024, the average cost of holding an active fund—considering management fees, custody fees, and transaction fees—hovered around 2.55%, while passive funds maintained an annual cost of about 1%.

If active funds were delivering alpha returns compared to passive funds, higher fees might have been justifiable. However, when long-term returns lag behind passive offerings, coupled with higher fees, it's no wonder investors are opting for the latter.

Moreover, the variety of passive fund types available—covering equities, bonds, commodities, currencies, and more—provides significant choice for investors. Beyond domestic markets, there’s the opportunity to invest in overseas ETFs that indirectly track U.S., Japanese, or European stocks, allowing investors to bypass individual stock risks and the pitfalls of style drift that often plague actively managed funds.

Leveraging a basket of underlying stocks that an index covers offers a means of pursuing moderate yield while forgoing the pursuit of high volatility returns, aligning with a growing preference among average investors. Such trends are visible in established markets like Europe and America, and are becoming increasingly apparent in the A-share market as well.

The A500 made its debut in October as a new option in the ETF marketplace, prompting discussions among investors regarding which of the A500 or CSI 300 offers superior advantages.

In terms of index composition, the CSI 300 employs market capitalization—primarily driven by transaction volume—as its main selection criterion, with an average constituent market cap of 189.9 billion yuan.

Conversely, the A500 index employs a more modern approach, prioritizing a balance of "scale" and "industry diversity." Additionally, it excludes stocks rated C or below by ESG standards and requires participation in either the Shanghai-Hong Kong or Shenzhen-Hong Kong Stock Connect.

From the perspective of market capitalization, the A500 index features some companies with a lower valuation than its counterparty. It consists of 165 stocks worth over 50 billion yuan, compared to the CSI 300's 206 stocks in the same cap range. Notably, the A500 includes 26 stocks valued between 5-10 billion yuan and another 2 valued below 5 billion yuan. On average, the A500's constituent stocks have a market cap of 109.9 billion yuan, which is decidedly lower than that of the CSI 300.

Examining industry allocations, substantial differences exist between the two indices. The top three weight sectors in the CSI 300 are banking, non-banking financial services, and food and beverages, accounting for 33.17% collectively, with proportions of 12.02%, 11.36%, and 9.79% respectively.

On the other hand, the A500's leading sectors are electronics, electrical equipment, and food and beverages, totaling only 27.21% (10.19%, 8.79%, and 8.23% respectively). Notably, banking and non-banking financial services contribute only 14.4%, far less than CSI 300's 23.4% allocation. This indicates a more balanced industry configuration in the A500, mitigating the heavy weighting of large-cap sectors like banking.

When it comes to profitability, the CSI 300 outperforms the A500. The CSI 300 boasts a gross profit margin of 19.12%, a net margin of 12.3%, and a return on equity (ROE) of 8.07%, all marginally higher than the A500's figures of 18.29%, 10.05%, and 8.05% respectively.

In terms of valuations, the A500 index carries a slightly elevated price-to-earnings (P/E) ratio when compared to the CSI 300. As of November 18, the A500's latest P/E stood at 14.3 times, below its median valuation of 14.85 times since its inception in 2004, yet higher than the concurrent P/E of the CSI 300, largely driven by the heavier inclusion of bank stocks in the latter's composition, which depresses overall valuation metrics.

Considering long-term performance, from the baseline date of December 31, 2004, through November 18, 2024, the A500 index has achieved a cumulative return rate of 365%, outpacing the CSI 300’s return of 276.5%, with annualized yield rates of 8.28% and 7.08% respectively.

In summary, while both the CSI 300 and A500 possess distinctive advantages and disadvantages in their methodology of composition, industry allocations, profitability, and valuation levels, historical performance indicates that the A500 has delivered superior long-term returns, potentially making it a more compelling choice for future investments.

Specifically, the Huaxia Fund's A500ETF (512050) deserves close attention from investors. The fund sold out on its debut day, achieving a relatively robust product scale with management and custody fees of just 0.15% and 0.05%, placing them among the lowest in the competitive market.

In the realm of broad-based ETFs, the performance of long-term returns can be described as average at best. In contrast, specialized thematic ETFs have frequently outperformed broader indices, making them a favored option among some investors.

From December 31, 2004, to the present, among the 31 sectors covered by the Shenwan Securities classification, 21 of them have managed to surpass the performance of the A500 index within the same period. Leading the pack, the food and beverage sector has achieved an astounding cumulative increase of more than 100 times, with home appliances at 30.3 times. Other sectors, such as pharmaceuticals, computers, electrical equipment, defense-related industries, and building materials, have also exceeded a tenfold increase.

Among these sectors, some are bolstered by enduring growth narratives, suggesting they possess the potential to continue leading the broader market. Conversely, others, impacted by policy interventions or seismic changes to their growth narratives, may not deliver promising results going forward, as observed in the biopharmaceutical space.

Looking globally, sectors such as consumer goods and information technology are expected to sustain their long-term outperformance positions. Wind statistics reveal that since December 31, 2004, the highest-performing sectors in the U.S. stock market have been information technology, discretionary consumer goods, communication services, healthcare, and industrial sectors, with respective cumulative increases of 198 times, 57 times, 33 times, 14.9 times, and 12.4 times.

In the European stock markets, exemplified by the German market performance during the same period, the leading sectors have been discretionary consumer goods, technology, finance, industrials, and consumer staples, with cumulative growth of 16 times, 11.3 times, 7.4 times, 5.7 times, and 4.7 times, respectively.

Within the Japanese stock market, information technology, industrials, healthcare, discretionary consumer goods, and telecommunications remain prominent, achieving cumulative raises of 9 times, 8 times, 7.3 times, 6.6 times, and 6 times accordingly.

This evidence from leading global stock markets demonstrates that consumer sectors and information technology consistently outperform other industries or mainstream indexes.

What underlying factors propel this phenomenon?

First, examining the consumption sector, it represents an enduring human need, where consumer firms typically require minimal ongoing investment and carry limited liabilities, allowing them to generate massive amounts of free cash flow consistently. This positions it as one of the most favorable business models. Companies like Guizhou Moutai in China, Coca-Cola in the U.S., LVMH in Europe, and the three major trading companies in Japan exemplify outstanding stock performance within the consumer domain.

The information technology sector encompasses several subfields, such as semiconductors and artificial intelligence, serving as the core engines driving global macroeconomic performance, with long-term growth potential surpassing numerous other sectors; thus, capital markets frequently assign them higher valuations and clearer paths to long-term excess returns.

Particularly in the U.S. stock market, core constituents like Apple, Microsoft, TSMC, Broadcom, and NVIDIA have yielded cumulative increases of 198 times over the past two decades, eclipsing A-shares’ strongest sector—the liquor sector—at 148 times.

Overall, the market functions as a weighing machine over time. Sectors like information technology and consumer goods have consistently proven their reliability regarding long-term performance growth, making it highly likely they will continue to lead the market. Therefore, ETFs relating to these sectors are worth monitoring, as their long-term outlook appears promising.