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Commerzbank and China Asset Management take two-pronged approach to China

Commerzbank Corporates & Markets/China Asset Management – China Volatility Target Fund

China Volatility Target Fund

Type: Sicav

Aim: Growth by investing in Chinese equities and a volatility strategy using derivatives

Minimum investment: Lump sum £1,000, euro 1,000

Investment split: 100% in Chinese equities and derivatives

Place of registration: Luxemburg

Charges: Initial 5%, annual 1.75%

Commission: Initial 3%, renewal 0.5%

Tel: 020 7623 8000

This Luxemburg Sicav takes a two-pronged approach to generating growth from Chinese equities. It combines an actively managed portfolio of 30 to 60 Chinese equities selected by China Asset Management with a derivatives strategy run by Commerzbank that reduces exposure to volatile markets, while allowing full market exposure in rising markets. This strategy works by taking long and short futures positions on the Hang Seng China Enterprise index or Hang Seng index, depending on how the fund’s volatility compares with its 20 per cent target.

Discussing the ways in which this product good for IFAs and their clients Michael Philips proprietor Michael Both says: “It is very appealing to be offered what we perceive as the upside potential of the Chinese stockmarket with underlying GDP growth at over 8 per cent a year without the downside volatility risk. The big questions are is this realistic and might this fund achieve it?”

Both feels that Commerzbank has launched an innovative fund using China Asset Management, a leading active asset manager in China, to maximise growth above market returns. He points out that this alpha generation is combined with what the company calls “systematic volatility targeting” to reduce downside risk.

“Commerzbank theorises that SVT will reduce the impact of market declines on portfolio returns without the need to move into cash. It is not aiming to eliminate falls or to be an absolute return fund, just to mitigate their effects. Buying and selling big blocks of shares is expensive and could move the market against the fund, always assuming there is the necessary liquidity, hence the use of the deeper and liquid proxy of the Hang Seng Index futures market,” says Both. He adds that daily liquidity and valuation within a Luxembourg registered Ucits Sicav structure with a minimum investment of £1,000 are useful features.

Turning to the potential drawbacks of the fund Both says: “China’s economy may grow faster than Europe or the US but that does not automatically imply that investing in Chinese shares is a one way bet. Investors must expect high volatility – something the financial crisis should have well prepared them for.”

Both thinks that China’s demography means it will very soon have a rapidly ageing population and that will have unpredictable results on GDP growth. “The methodology for reducing the impact of price volatility, as described in the literature, looks less than robust. If one is to take it at face value, not only is there a significant risk of mis-timing the hedging – which could seriously compromise the returns – but also the use of futures on the Hang Seng Index may not be an accurate proxy for the long portfolio.”

He adds that it is also likely to be expensive at the times when hedging is needed because when the market is volatile, volatility hedges will rise in price.

Both has reservations about how the strategy will work in practice. “If relying on novel strategies which have only been proved by being back-tested against historic data, there is a significant danger that the strategy which has been over-optimised to work with a specific set of data may, in practice, behave very differently when confronted with reality,” he says.

According to Both, two long-only China funds will provide the main competition. These are GAM star China equity and First State Greater China growth.

Summing up Both says: “If one examines the performance of Commerzbank’s UK long/short fund, it closely tracked the FTSE 100 from October 2009 to June 2010 – after which the FTSE rose 10 per cent while the fund fell 5 per cent. The story for its Europe long/short fund is no better. It launched in February 2010, mirrored the Europe ex-UK index to about mid-May, then dropped 10 per cent while the index rose 4 per cent.”


Suitability to Market: Poor

Investment Strategy: Poor

Charges: Average

Adviser remuneration: Average

Overall 5/10


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