(Bloomberg) -- Chinese investors have ignored a warning from the issuer of the largest onshore exchange-traded fund tracking the Japanese market, flocking to ride the gains despite cracks showing in the ETF’s rally.  

The China AMC Nomura Nikkei 225 ETF closed 1% lower even after touching a daily limit of 10% when trading resumed at 10:30am local time. The shares had been suspended for an hour after the fund traded at a 9.5% premium over its underlying net assets on Tuesday, triggering a caution from the fund’s manager.

“The transaction price in the secondary market is significantly higher than the reference net value of fund shares, resulting in a substantial premium,” China Asset Management Co. said in a statement. “If investors invest blindly, they may suffer serious consequences.”

Local investors, bruised from a relentless stock rout at home, are seeking refuge in Japan’s booming market after the Nikkei 225 index hit a 34-year high. Meanwhile, the CSI 300 Index is languishing at its lowest level since 2019 amid concerns over China’s economic recovery and a lack of catalysts.

“Gains of over 20% last year in Japan gauges have altered the typical view that its economy is in a long-term recession and the stocks are under downward pressure,” the China Securities Journal reported the ETF fund’s manager Zhao Zongting as saying.

Turnover in the China AMC Nomura ETF fell on Wednesday to 4 billion yuan ($556 million), after reaching a record 4.8 billion yuan in the previous session. Its premium rose to 10%, dipping from 13% on Monday. 

While ETF price gaps are often quickly corrected, the deviation for Japan-related products might last. Most mainland investors don’t have overseas stock accounts and face capital controls, making ETFs one of the most convenient ways to bet on foreign stock markets.

However, one of the underlying factors behind the distorted pricing for the China AMC Nomura may be easing. Some fund houses are allocating more Qualified Domestic Institutional Investor quota to onshore Japan ETFs to curb further divergence of prices from their net value and reducing premiums, The Paper reports, citing an unidentified industry source. The measure may help address a supply and demand imbalance that’s been inflating the premium.

It isn’t uncommon for premiums of onshore ETFs tracking offshore assets to surge. The E Fund Crude Oil Fund soared as much as 118% over the underlying shares in 2020, while the E Fund CSI Overseas China Internet 50 ETF Index Fund and Guotai Nasdaq 100 Index Exchange Traded Fund have seen premiums rising above 25%. 

“The price of Japan ETF funds are impacted by an increase of risk appetite and sometimes overheated sentiment by domestic investors, which brings high premiums,” according to Li RuiMin, a fund manager of the ICBC Credit Suisse Daiwa ETF. That fund is trading about 1.1% higher on Wednesday, with a premium of 3.8%, according to fund tracker Eastmoney.

“Retail investors should be rational and limit exposure and refrain from chasing gains when high premiums are present,” said Li. 

--With assistance from Amanda Wang and Jack Wang.

(Updates numbers throughout, adds media report in eighth paragraph.)

©2024 Bloomberg L.P.