The writeup is short to be timely.

This opportunity is probably only suitable for PA due to small size and limited liquidity. 

All $ in HKD

Ping An CSI RAFI A-SHARE 50 ETF (HK: 2818) is about to liquidate itself and we believe the current situation offers good risk adjusted return.

The fund was set up to mimic the performance of Chinese domestic market (A shares), for details of its current holdings, check out the following link:

http://asset.pingan.com.hk/eng/2818#f1

Ping An Asset Management, the manager of the fund, has decided to terminate and liquidate the fund. The reason for liquidation is small NAV, only about $9M right now.

Here is what will happen next:

08/25,  the last trading day for the units on Hong Kong stock exchange.

08/26,  the units will stop trading and the whole portfolio will be liquidated

08/28,  record date for receiving Interim Distribution and CGT Provision Refund (explained later)

11/28,  Interim Distribution, NAV will be paid out to unit holders.

12/09/2019, deadline for CGT Provision Refund.

Current NAV per unit is about $15.60 and current trading price pre unit is about $16.04. So if you buy units at $16.04, you will get $15.60 back on 11/28, give or take the stock price movements between now and 08/25, which is next Monday.

So for about $0.44, what are we getting?

The fund made two provisions, the first one is the Capital Gain Tax provision of $3.42 per unit ($1.7M in total) and the second one is future expenses provision of $3.84 per unit ($1.9M in total). These two provisions have already been deducted from the NAV. We believe the upside will come from the elimination or reduction of these two provisions.

Let’s look at the Capital Gain Tax Provision (CGT Provision) first. Generally, under current Chinese laws and regulations, capital gains realized on the sale of A shares are subject to 10% withholding tax. However, to date, the Chinese tax authorities have not sought to collect such withholding tax on capital gains realized by QFIIs (Qualified Foreign Institutional Investors) on the sale of A shares, although to meet potential tax liability, a 10% provision has always been made.

The holding period for the CGT Provision is set to be five years, thus 12/09/2019. We can extract value from CGT Provision by getting refund under several scenarios: for example, the Chinese tax authority could decide that QFIIs are exempt from paying capital gain tax or are required to pay at a lower rate. Or the Chinese tax authority could decide the capital gain tax will not be applied retrospectively. If by 12/09/2019, there is still no clarification from the Chinese tax authority regarding QFII capital gain tax, we will get the full refund back as well.

By the way, the CGT Provision is all the unit holder is liable for. If the Chinese tax authority decides to impose a higher tax rate or collect money after the Provision has been refunded, Ping An Asset Management will have to pick up the tab.

It is difficult to put a value on CGT Provision refund since we don’t know how likely the Chinese tax authority will impose capital gain tax on QFIIs and at what rate. But we think we are getting this for free anyway, because very likely we will get the other provision back.

After the Interim Distribution (11/28), the fund manager intends to continue to run the fund, though in a limited fashion, till the CGT issue is resolved (12/09/2019 the latest). It has reserved $3.84 per unit for future expenses such as trustee fees and so on. We don’t think it is in the unit holders’ best interest to drag this thing for five years and pay all the unnecessary expenses along the way. We have been in touch with a group of investors who collectively own more than 50% of the units. Their plan is to call a special meeting soon after the Interim Distribution date and propose to “Deauthorise” from Hong Kong SEC and Delist from the exchange as soon as possible. They will need 75% of units to prevail. The expenses will come down dramatically once the fund is “Deauthorised”. For example, trustee fee alone was $840K per year. Since the $3.84 per unit expense was intended to cover a five year period, we should be able to save a big chuck of it if we can get the fund “Deauthorised” in several months instead of years.

To summarize: our cost is about 45 cents, let’s be conservative and assume we will only get 30% of expenses provision back and that will be $1.30. On top of that there is still the possibility of CGT refund.

Risks:

The stock prices of current portfolio holdings drop significantly between now and 08/26. We don't think this is likely, if anything, the A share market has been showing bullish signs

Unable to "Deauthorize" the fund quickly therefore have to incur unnecessary expenses