Rising Demand for Active and Buffered ETFs in China: Navigating Volatility with Strategic Allocation

China's financial markets have long been a barometer of global economic uncertainty, and investors are increasingly turning to active and buffered ETFs to mitigate risk while capitalizing on growth opportunities. As regulatory shifts, geopolitical tensions, and market volatility intensify, a strategic pivot toward these tools is reshaping asset allocation strategies. This article explores the drivers behind this trend and its implications for investors.

The Catalyst: Volatility and the Hunt for Downside Protection

China's equity markets have faced significant headwinds in recent years, with the iShares MSCI China ETF (MCHI) down 8.5% year-to-date (as of early 2025) amid regulatory crackdowns on tech giants and macroeconomic slowdowns. Traditional passive ETFs, which mirror indices like the CSI 300, have struggled to deliver consistent returns. In response, investors are gravitating toward active ETFs, which employ dynamic strategies to outperform benchmarks, and buffered ETFs, designed to limit losses while still participating in upside potential.

Active ETFs: A Growing Trend

According to the BBH Greater China ETF Investor Survey 2025, 40% of investors in Hong Kong and Taiwan plan to increase allocations to active ETFs by over 25% in the next 12 months. In mainland China, 34% of investors target buffered ETFs, while 20% focus on ESG-themed products. This shift reflects a broader rejection of passive strategies in favor of proactive management.

Key drivers include:
1. Risk Mitigation: Active managers can adjust holdings in volatile sectors like tech and real estate.
2. Alpha Generation: Investors seek outperformance in a low-yield environment.
3. Regulatory Tailwinds: Streamlined approvals and reduced fees for ETFs have spurred innovation.

Buffered ETFs: The New Frontier in Capital Preservation

The launch of KraneShares' 100% KWEB Defined Outcome ETF (KPRO) and 90% KWEB Defined Outcome ETF (KBUF) underscores investor demand for downside protection. These products, tied to China's struggling internet sector (KWEB), aim to limit losses to 0% or 10%, respectively, while allowing full participation in upside gains.

While buffered ETFs have attracted skepticism due to their structured nature, they align with a key insight from the BBH survey: 29% of Greater China investors prioritize defined-outcome strategies, rising to 34% in mainland China. This suggests a structural shift toward tools that balance growth and safety.

Structural Drivers and Opportunities

1. Thematic Innovation: Active ETFs are increasingly tied to themes like AI (31% of allocators see it as a 2025 priority) and ESG, catering to both growth and values-driven investors.
2. Global Benchmarks: With Asia-Pacific ETF AUM hitting $1.37 trillion by mid-2025, China's market is a linchpin. Active strategies now account for $12.8 billion in net inflows YTD, despite June's brief outflows.
3. Regulatory Support: China's push for market liberalization, including easier ETF approvals, has accelerated product launches. By mid-2025, 166 ETFs had debuted, surpassing half of 2021's record issuance.

Considerations and Risks

• Transparency Challenges: Active ETFs face debates over daily holdings disclosure, though semi-transparent models may gain traction.
• Costs: Active and buffered ETFs often carry higher expense ratios than passive peers.
• Market Cycles: Success hinges on managers' ability to navigate sector-specific risks, such as tech regulation or real estate downturns.

Investment Implications

For investors, the rise of active and buffered ETFs offers both opportunities and cautions:
1. Diversify with Purpose: Allocate to active ETFs in volatile sectors (e.g., tech, real estate) while using buffered products to protect core holdings.
2. Monitor Fees and Strategy: Opt for low-cost, well-researched funds with proven risk management frameworks.
3. Stay Thematic: ESG and AI-focused ETFs align with long-term trends and regulatory priorities.

Conclusion

China's ETF market is undergoing a paradigm shift, with active and buffered strategies emerging as critical tools for navigating uncertainty. While passive ETFs remain dominant, the 34% of mainland investors prioritizing buffered ETFs signal a lasting preference for downside protection. As regulatory support and innovation continue, these products will likely capture a larger share of inflows. For investors, this is not just a tactical adjustment—it's a strategic reallocation to thrive in an era of heightened volatility.

Final advice: Pair buffered ETFs with active managers skilled in China's unique risks, and keep a watchful eye on geopolitical developments.