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China stock traders bet US$305m on military tensions

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[SHANGHAI] China's stock investors are making a US$305 million bet on the nation's military complex.

That's the total that Guotai Asset Management Co, GF Fund Management Co and Fortune SG Fund Management Co raised since July from selling the nation's first exchange-traded funds following defense shares.

The funds track the CSI National Defense Industry Index, which was up 18 per cent from its May low as of Monday, outpacing the Shanghai Composite Index's 9.4 per cent rebound.

The ETF creators are seeking to capitalise on escalating geopolitical tensions, with an international tribunal ruling in July that China's efforts to assert control over the South China Sea exceeded the law and South Korea agreeing to allow the US to deploy an anti-ballistic missile system on the peninsula.

China is expected to upgrade its military equipment and let more weapon-making units access the capital market, according to GF Fund Management.

"There's surely decent demand for the ETFs and the size will expand quickly," said Wang Chen, a partner at Xufunds Investment Management Co in Shanghai.

"It's a pretty good asset allocation as it covers a basket of companies in the industry. If there's more geopolitical tension going forward, the ETFs stand a big chance of outperforming the broader market." Mr Wang said he's considering investing in the funds.

Last year's US$5 trillion stock rout dealt a blow to China's developing ETF market, spurring an eight-month hiatus in new funds. This year, the military ETFs and three other products are the only ETFs to start, according to data compiled by Bloomberg.

"The military stocks will get a shot in the arm from the complicated geopolitical situation and China's territorial disputes with neighboring countries," said Ai Xiaojun, the Shanghai-based fund manager of Guotai CSI National Defense EFT. "The industry's earnings growth will exceed that of the broader market over the next two and three years."

The defense gauge comprises 72 companies including Avic Aviation Engine Corp, Avic Aircraft Co and North Navigation Control Technology Co, according to China Securities Index Co, the index compiler that's jointly owned by the Shanghai and Shenzhen stock exchanges.

The Shanghai Composite was little changed at 10.56am local time. Avic Aviation Engine and Avic Aircraft both fell more than 2 per cent.

President Xi Jinping announced a sweeping overhaul of the military in November, unifying the infantry, navy, air force and strategic missile corps under one command.

His plan to cut the world's largest army by 300,000, the most since 1997, will probably lead to an increase in the budget for equipment procurement and upgrades, UBS Group AG said in a July note.

Because there are no listings of Chinese defense companies in Hong Kong or the US, foreign investors seeking to buy such shares will favour the ETFs, Xufunds Investment's Mr Wang said.

"The fundamentals of China's military industry are quite positive and there are lots of catalysts from regional events," said Guotai Asset's Mr Ai. "We are not pessimistic about the general performance of China's stock market in the second half so it's good timing to invest in the ETF."