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Forget FXI: Try These Three China ETFs Instead

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As the emerging world continues to rise both in importance and as a component of investor portfolios, a number of countries and their economic situations are increasingly on investors’ radars. Yet, one nation seems to dominate the discussion time and time again thanks to its massive size, impressive growth rate, and incredible potential; China. Unfortunately, China has hit a speed bump as of late, as the national economy has seemingly slowed down in the face of developed market woes and rising inflation concerns. Furthermore, to combat these rising prices, the country has become increasingly tight in its monetary policy, further dragging growth down in the still emerging nation. With that being said, recent developments should be encouraging to many who are focused on the space and could suggest that a turnaround to the year’s disastrous performance could be at hand.

In a surprise move, the People’s Bank of China announced that it will cut the reserve-requirement ratio for banks by fifty basis points, marking the first such move in nearly three years for the central bank. The markets rejoiced the news as the slash in the ratio gives banks the ability to lend out more of their capital, potentially boosting growth across the nation. In fact, according to the Wall Street Journal, the cut should free up close to $61 billion for lending and with more cuts likely over the next couple of months, the Chinese economy could begin to return to extremely strong levels of growth before too long (see Inside The SuperDividend ETF).

The move also marks a reversal in policy as the central bank had already raised the ratio six times over the course of the year in order to combat rising inflation, but this appears to be a lesser concern for the bank now. “The public nature of this move – a move that would have gone through the State Council – is a clear signal that Beijing has decided that the balance of risks now lies with growth, rather than inflation,” wrote Stephen Green, a China economist at Standard Chartered Bank, in a research note. “This is a big move, it signals China is now in loosening mode.” Thanks to this, investors began to scoop up Chinese assets once again, helping to push broad indexes in the country sharply higher on the day on hopes that further cuts could be seen and that inflation is finally starting to get under control (see BDCL: Yield King Of Leveraged ETFs).

China ETFs In Focus

For those seeking holdings in Chinese stocks, ETFs are increasingly vital for achieving broad, cheap exposure to the space. Unarguably, the FTSE China 25 Index (FXI - Free Report) is the most popular ETF for investors seeking targeted China exposure.  The fund has over $6.5 billion in assets and trades close to 19 million shares a day, giving the product extremely tight bid/ask spreads that can often times be less than a few pennies wide. However, a closer look at the fund’s holdings should leave much to be desired for pretty much all investors.

FXI while extremely liquid, only has 26 securities in its basket and even then, the fund is very focused on just a few sectors. In fact, financials comprise nearly 48.2% of the portfolio while oil, telecommunications, and basic materials each comprise at least 12% of the fund as well. This leaves nothing for consumers, technology, health care, or a host of other important sectors in the Chinese economy. Furthermore, the fund is entirely focused on large cap securities with China Mobile (CHL - Free Report) , China Construction Bank and the Industrial & Commercial Bank of China taking up the top three spots in the fund. Given how liquid these securities are and how few stocks are in the basket, one has to feel that the expense ratio is rather high for FXI, coming in at 72 basis points a year (read HDGE: The Active Bear ETF Under The Microscope).

Thanks to these limitations and issues, many might be better off looking at any number of other products in the space. These securities can either provide better diversification or help to plug holes that may be in a China-focused portfolio than only has an investment in FXI. Below, we highlight three of our favorite ETFs in the China space that could make for a fantastic compliment or even a better investment than the overly-concentrated, but wildly popular, FXI:

Guggenheim China Small Cap ETF (HAO - Free Report)

If you are looking for a small cap way to play the Chinese market, HAO is one of the few choices available. The fund consists of about 200 securities and is based on the AlphaShares China Small Cap Index, which is a benchmark designed to measure the performance of the publicly-traded mainland China-based small capitalization companies. In order to qualify for the index, firms must have a maximum $1.5 billion market cap, giving the product a weighted average float-adjusted market cap of about $688 million. This focus results in a portfolio that is heavy in industrials (20.2%), materials (17.8%), and consumer discretionary firms (16.3%) while giving minimal weightings to energy, telecom and utilities. With this may be appealing to investors, in times of broad declines in the Chinese market the fund tends to underperform its more large cap focused counterparts as it did in 2011 by a wide margin. However, this has given the product a P/E of just 6.7 and a P/B ratio below 1, suggesting deep value may be had for long term investors.

Global X China Consumer ETF (CHIQ - Free Report)

Since FXI’s exposure to consumers is limited to say the least, this fund from Global X could serve as a great compliment to the iShares fund. The fund tracks the Solactive China Consumer Index which is a benchmark of the consumer sector in China. The index is comprised of selected companies which have their main business operations in the consumer sector and are domiciled in China, or firms that may do a majority of their operations in China but are domiciled in a country besides China. This results in a portfolio of about 40 securities tilted towards the large cap space but with a decent allocation to mid cap securities as well. Top industry holdings include retail (25.3%), food (19.9%), and automobiles (19%) while giving top weights to Hengan International, Want Want China Holdings , and Tingyi Holding Corp. CHIQ charges investors an expense ratio of 65 basis points a year for its services and trades on decent volume of about 130,000 shares a day (see Top Three Precious Metal Mining ETFs).

Market Vectors China A-Shares ETF (PEK - Free Report)

For those seeking a new way to diversify in the space, PEK is an excellent way to accomplish the task at hand. This is because unlike other ETFs in the space which track broad indexes of ADRs or stocks that are available to Western investors, this fund tracks the China A-Shares market instead. This market, as represented by the CSI 300 Index, consists of 300 A-Share stocks listed on the Shenzen or Shanghai Stock Exchange. However, it is important to note that these securities are only available to a select group of people outside of China. In fact, one has to be a Qualified Foreign Institutional Investor (QFII) to be eligible for purchasing these securities. As a result, PEK does not invest directly in A-Shares, but instead invests in swaps and other types of derivative instruments that have economic characteristics substantially identical to those of China A-Share stocks. Thanks to this structure, the fund can often trade at a significant premium to its underlying securities and can often deviate from the broad market performance based on the supply/demand of shares available through the QFII program.

Nonetheless, securities that are on this benchmark are often different from their Hong Kong listed counterparts and can often have unique experiences from these securities. Additionally, the A-Shares market is denominated in renminbi as opposed to the H-Shares market (Hong Kong dollars) or the B-Shares market (various foreign currencies) making a bet on PEK a closer move on the Chinese currency as well. Investors should also note that the index’s underlying holdings are generally similar to FXI, at least in terms of sector exposure. Financials take up the top spot while industrials and materials round out the top three. However, in a departure from FXI, consumers and energy firms take up another 20% combined while a smattering of other sectors round out the rest. Overall, PEK does offer a more diversified profile than its FXI cousin although investors should remember that this Van Eck fund is far less liquid, trading a paltry 7,000 shares a day.  

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