Why This China ETF Should Continue Working

Over the past month, exchange-traded funds tracking Chinese A-shares, stocks trading on the mainland of the world's second-largest economy, figure prominently on the top 10 list of worst-performing non-leveraged ETFs.

Of course, that is good news for the Direxion Daily CSI 300 China A Share Bear 1X Shares (NYSE:CHAD), a fund that has been highlighted multiple times in this space over the past two months.

With Friday's gain of about 2.4 percent, CHAD is up nearly 7 percent over the past month and more than 21 percent over the past 90 days. Those are not staggering gains, but remember CHAD is not a leveraged ETF. In a perfect world, when China's widely followed CSI 300 Index falls 1 percent on a particular day, CHAD should rise by the same amount.

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What It Means

As A-shares have tumbled in recent months, investors have endured situations such as days where half the stocks trading on the mainland where halted by Chinese regulators and ineffective market interventions, a tool Beijing has since told market participants that they should not become too dependent on.

Those scenarios and others are fuel for CHAD's fire, perhaps explaining why for every $2 that has flowed out of the largest U.S. A-shares ETF this month, nearly $1 has found its way to CHAD. CHAD looks primed for further near-term upside when considering the role of retail investors in the mainland China market.

Retail Participation Concerns

Yet, there are valid reasons to be concerned about retail participation in the equity market, said Research Affiliates in a new research piece on China. Nave speculation in the stock market has features in common with smoking and pathological gambling. Smokers face horrible illness and early death; compulsive gamblers face ruination.

Moreover, smoking and addictive gambling have negative externalities. Smoking produces harmful second-hand smoke and contributes heavily to the cost of health care, while pathological gambling breaks families apart and fosters crime. Likewise, nave speculators active trading has negative externalities: By adding noise to the price discovery process, it can actually decrease market efficiency, and damage the real economy in the process.

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Retail investors' impact on A-shares is compelling as it pertains to CHAD because inverse and leveraged ETFs are often thought to be suckers bets used primarily by retail traders, not professionals. However, CHAD, as of September 17, had hauled in over $245 million in assets in just three months of trading. That easily makes it one of the most successful new ETFs to come to market this year.

In a very inefficient stock market dominated by retail trading, taking advantage of credulous investors becomes a powerful profit engine for owners of listed firms and traders at hedge funds and other financial institutions. This turns the stock market mostly into a wealth transfer mechanism with little positive benefit to the real economy, added Research Affiliates.

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