Courtesy of the ETF Professor at Benzinga.com 
Following the March 22 debacle concerning the VelocityShares Daily 2x VIX Short-Term ETN (NYSE: TVIX that saw the now infamous ETN tumble 30% in that one trading day, traders and investors predictably wondered what exchange-traded product could be next to fall victim to a similar scenario.
That scenario being an ETF or ETN trading at an elevated premium to its net asset or indicative value. One fund that has been noticed trading at elevated premium’s to its NAV is the Market Vectors China ETF (NYSE: PEK [6]) and this has been the case since the ETF debuted in October 2010.
What some investors may not understand is the reason why the Market Vectors China ETF has previously traded at premiums to its NAV that have been as high as 12%, sometimes a tad more. PEK is the only U.S.-listed ETF that offers investors exposure to China’s A shares market, but since foreign investors are limited in owning Chinese A shares directly, PEK uses swaps and derivatives instruments to accomplish its objectives.
Noteworthy is the fact that PEK’s premium has started to shrink, coinciding with news announced earlier this month that the China Securities Regulatory Commission boosted the quotas for qualified foreign institutional investors to $80 billion from $30 billion.
Chris Hempstead, head of ETF trading for New York-based execution firm WallachBeth Capital, talked about the implications increased access to China’s A shares for foreign investors may have on PEK in an exclusive interview with Benzinga on Friday.
“PEK trading an elevated premium to its NAV in the past was not a function of it not being able to create and redeem shares as was the case with TVIX,” Hempstead said. “There are completely separate reasons why PEK’s NAV has been elevated compared to TVIX and some of the other products.”
Hempstead explained that it is the process by which PEK accesses China’s A shares market that has led to the high premium to its NAV in the past.
“PEK goes to a bank and enters a swap agreement, but because China’s A shares aren’t easily accessible, the bank has to charge a higher premium on the swaps to hedge its own risk,” Hempstead said. “That leads to the premium to NAV in PEK.”
PEK is currently comprised of almost 38,000 CSI300 TR Index swaps with a notional value of over $16.6 million, according to the Van Eck Web site [7]. The counter-party for PEK’s swap exposure? Credit Suisse (NYSE: CS [8]), TVIX’s issuer.
Hempstead notes that PEK’s premium to its NAV has declined following the news that China is gradually warming to increased foreign investment. At the close of markets on March 22, PEK’s premium to NAV was 8.5%. At the start of trading today, the premium had shrunk to 2.7%.
“One risk to a collapse in premium in PEK is that later investors will get better pricing because of the fallen premium,” according to Hempstead. “From a structural standpoint, PEK does what it’s supposed to do.”
For more on China ETFs, please click HERE [9].