As of January 17, the Nikkei 225 index has soared over 35% in the past year, demonstrating remarkable growth momentum that has continued into 2024 with an increase of 6.02% thus farThe strength of this index is not merely a reflection of Japan's market dynamics but a lure for investors worldwide, particularly in China, where various exchange-traded funds (ETFs) tied to the Nikkei 225 are witnessing significant trading activity.

One of the most notable ETFs has been the Huaxia Nikkei 225 ETF, which has captured the attention of investors to the extent that it hit a trading halt on mandates from the stock exchangeOn January 17, reports indicated that the premium rate of the Huaxia Nikkei 225 ETF reached an alarming 9.99%. Just a day prior, it had peaked at over 20% during intraday trading, highlighting the volatility and investor eagerness in the market.

Despite multiple warnings issued by Huaxia Fund about the impending premium risks over just five trading days starting January 11, the enthusiasm from investors did not wane

This stark difference between the market price and the fund's net asset value raises eyebrows and signals potential concerns.

Analysts have pointed out that while the Japanese stock market has climbed impressively, sustaining this upward trajectory might present challenges aheadThey caution that Chinese investors are confronted with quadruple pressures from liquidity, exchange rates, economic fundamentals, and monetary policy, advising a more cautious approach towards the Japanese market over time.

A Risky Premium of Nearly 10%

On the same day, Huaxia Fund publicly recognized that the market price of the Huaxia Nomura Nikkei 225 Exchange-Traded Fund (QDII) was significantly elevated compared to its reference net asset value, representing substantial premiums that warranted investor caution.

Investors could buy and sell on the secondary market or choose to subscribe and redeem shares

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However, the fluctuating trading price exposes them not only to net asset value risks but also to broader market risks such as supply and demand dynamics, systemic risks, and liquidity challenges, potentially leading to significant losses.

In an effort to protect investors' interests, trading of the Huaxia Nikkei 225 ETF was suspended from market opening until 10:30 AM on January 17, only to resume later with an impressive surge exceeding 7% post-resumption.

The ETF ultimately closed 1.03% lower by the end of the trading day, yet saw a staggering turnover rate of 533.82%. Alarmingly, the ETF still operated at a profound premium with rates up to 9.99% and a discount rate hitting 8.4%. Such extremes were reminiscent of previous days' activities, prompting a call for caution among investors.

With a fixed quota on QDII funds, Huaxia Fund has actively sought to allocate more QDII quotas towards the Nikkei 225 ETF to mitigate these premium rates

The daily cap for share subscriptions was increased progressively, from 2 million shares on January 15 to 3 million the next day, culminating in a daily limit of 7.5 million shares by January 17.

Many investors seek tangible results from their investments, especially when corresponding indexes riseThe QDII option serves as an accessible entry point for those looking to tap into overseas markets at a lower costHowever, with limited fund availability and foreign exchange quotas influencing market reaction, sudden surges in demand lead to pronounced trading premiums, according to Rong Hao, a partner at Paipai Financial Management.

Caution Must Prevail

According to data from Eastmoney, the Nikkei 225 Index had surged over 35% within a year leading up to January 17, mirroring the strong attraction for investors as they flood the market, driving the prices further inflating against the index.

Bank of Communications Schroders Fund also issued a premium risk warning on January 17, underscoring that the market trading price for their Nikkei 225 ETF was significantly surpassed by the reference net asset value, advising investors of the risks associated with blindly investing.

Commenting on these price fluctuations, Rong Hao noted that such situations carry inherent trading premium risks, similar to the dangers of any overheating trading asset

Attention should also be drawn to exchange rate fluctuations, as they profoundly affect overall asset allocation strategy and market interest.

Research from Galaxy Securities indicated that the Japanese market's upward trends stem from both economic and financial stimuliHowever, they warned that these driving forces might face reversal in 2024. As the Nikkei 225 further inflates in value, investors should be prepared to deal with pressures related to liquidity, currency exchanges, economic fundamentals, and monetary policies, cautioning against excessive optimism regarding the future of the Japanese market.

With predictions of interest rate cuts from the Federal Reserve and expectations of Japan exiting its negative interest rate policy, a robust appreciation of the yen seems likely