A Definitive Guide to China ETFs

by: Michael Johnston

By Jared Cummans

The impact of the recent global economic slowdown was first felt by consumers around the world who were forced to cut back on purchases in order to endure the recession. While some consumer segments such as the wealthy, have begun to spend again, the events of the last two years have also had a profound, and perhaps lasting, impact on the business of investing and the methodologies that guide the portfolio construction process. As the growth gap between the world’s advanced and developing economies widens, many U.S. investors have tossed aside the conventional wisdom that called for making a significant allocation to domestic equities in favor of a more global approach.

Historically, many investors have maintained only minimal exposure to emerging markets equities, citing the significant risk factors as justification for the minimum weightings. But in the current environment, many have pointed out that it is the developed economies of the world that are ripe with risk. Health care reform, drilling bans, and financial overhauls have been rolled out in the U.S., while Europe braces for harsh austerity measures that figure to impact several corners of the economy for years to come.

As U.S. investors have fought off their “home country bias,” many have significantly increased the allocation to Chinese equities in their portfolio, having been drawn in by the mind-boggling growth rates and tremendous potential of what will soon be the world’s largest economy. Exposure to China once was a binary attribute: either a portfolio had exposure, or it did not. Recent innovation in the ETF space has significantly changed this corner of the investing landscape; there are now more than 20 ETFs offering exposure to China, each with its own unique risk/return profile.

Below, we profile the most popular ETFs offering exposure to China. First, however, we take a quick look at some of the factors that impact Chinese markets.

China Price Movers

There are a number of factors that contribute to movements in the Chinese markets, some of which can be extremely unpredictable. Drivers of Chinese markets include:

  • Currency Regulation: China’s currency policy has sparked fierce debate globally for several years now, with many analysts accusing the government of manipulating the yuan to boost China’s export market. Although Beijing has indicated that it will allow the yuan to fluctuate, the exact ramifications of that decision remain to be seen.
  • Export Activity: Closely related to the exchange rate, export activity is a major driver of economic growth in China. For decades, China has been a net exporter of relatively cheap goods to advanced economies, including the U.S. and Europe. Historically, low labor costs have allowed Chinese companies to compete effectively with foreign products on the basis of price. Overseas demand regulates China’s exporting process, and when the rest of the world is under financial scrutiny, China may feel the pinch.
  • Infrastructure Development: Although many Chinese cities are among the most modern in the world, parts of rural China remain far behind the civilized world in terms of infrastructure. Growth of China’s economy depends on part on continued development and modernization of these remote areas.
  • Government Intervention: As a communist nation, China’s government has the ability to exert a significant amount of control over the private sector. Although China has become increasingly open to foreign investment in recent years, a number of sectors (such as financials) remain under heavy government influence.
  • Politics: Geopolitical tensions in Asia will inevitably impact China. Along with a long-standing feud with Taiwan, China is known as the chief supporter of the rogue regime in North Korea which has attracted attention as of late. Should Chinese growth rates slow down, it could create political instability and unrest which would ward off potential investors who are wary about allocating their money to an uncertain market.
  • Commodities: China is now the world’s largest user of energy, and accounts for a significant portion of global commodity demand. Because the country imports significant amounts of raw materials, Chinese industries are vulnerable to swings in commodity prices.

Large Cap China ETFs

Many of the largest ETFs offering exposure to Chinese equities are tilted heavily towards giant and large cap stocks. These ETFs include:

  • iShares FTSE China (HK Listed) Index Fund (NASDAQ:FCHI): This fund focuses primarily on giant market capitalization firms; FCHI focuses the majority of its assets in the financials (47%), energy (19%), and telecom (15%) sectors.
  • PowerShares Golden Dragon Halter USX China Portfolio (NASDAQ:PGJ): This fund tracks the Halter USX China Index, a benchmark that is comprised of the U.S.-listed securities of companies that derive a majority of their revenue from the People’s Republic of China. As such, PGJ offers a unique option for China exposure.
  • SPDR S&P China ETF (NYSEARCA:GXC): State Street’s GXC invests in a broad range of market sectors, allowing investors to have their hands in all corners of the China equity market. GXC tracks the S&P China BMI Index, a benchmark that measures the investable universe of publicly traded companies domiciled in China that are legally available to foreign investors.
  • iShares FTSE/Xinhua China 25 Index Fund (NYSEARCA:FXI): FXI is the biggest China ETF, but it certainly isn’t the most diverse. This ETF has about 25 holdings, and big weightings in the financials and energy sectors. FXI is light on consumer exposure, a potential drawback for investors looking to tap into China’s growing middle class.

Small Cap/All Cap ETFs

Small cap ETFs covering the U.S. market have long been popular with investors, but opportunities to access smaller companies listed in foreign markets have historically been limited. That is beginning to change, however, as investors focus more on the international component of portfolios and begin seeking out alternatives to large cap-heavy funds.

  • Claymore/AlphaShares China Small Cap Index ETF (NYSEARCA:HAO): HAO tracks the AlphaShares China Small Cap Index, a benchmark that includes companies with a float-adjusted market cap between $200 million and $1.5 billion. This fund gives investors more diverse exposure to the Chinese economy, making material allocating to all of the various market sectors. One other interesting note: this ETF gives no single holding a weight over 2.2%, adding to its already strong diversity.
  • Claymore/AlphaShares China All-Cap ETF (NYSEARCA:YAO): For investors looking to cover the whole spectrum of Chinese stocks, YAO is an interesting option. This fund gives a big weighting to energy and financials, but maintains a relatively balanced allocation overall.

Sector ETFs

Again, sector-specific funds covering various corners of the U.S. market are nothing new. But until recently there weren’t many options for investors looking to bet on a specific part of the Chinese equity market. Now, there are a handful of ETFs offering exposure to everything from energy to technology to infrastructure.

  • Global X China Technology ETF (CHIB): This technology centered ETF spreads its assets out over giant, large, and medium cap companies. With a heavy focus on the telecom sector, CHIB’s top holding comes from search engine giant Baidu Inc. (NASDAQ:BIDU).
  • Global X China Energy ETF (NYSEARCA:CHIE): CHIE tracks the S-BOX China Energy Index, a benchmark that includes significant allocations to alternative energy firms in addition to traditional oil and gas and coal-related stocks.
  • China Materials ETF (NYSEARCA:CHIM): CHIM allocates nearly all of its assets to the industrial materials sector, and spreads its assets across large, medium, and small cap firms.
  • Claymore China Technology ETF (NYSEARCA:CQQQ): Claymore’s CQQQ overlaps considerably with CHIB, as both offer exposure to Chinese tech companies. CQQQ has about 30 individual holdings, the largest of which are Tencent Holdings and search engine giant Baidu. CQQQ’s biggest allocations are to the telecom (52%) and hardware (15%) sectors.
  • China Industrials ETF (NYSEARCA:CHII): This ETF holds 32 securities that focus on the industrial materials and business services sectors. CHII offers exposure to a corner of the Chinese market that has exploded over the last two decades, accounting for a big portion of the country’s economic growth.
  • China Consumer ETF (NYSEARCA:CHIQ): CHIQ offers exposure to a corner of the market that most cap-weighted funds ignore. CHIQ’s largest holdings include China Yuran Food Group (5.6%), major sports brand Li Ning (5.3%), and Air China Limited (5.1%). CHIQ may be attractive for investors who expect that China’s middle class will continue to expand and accumulate wealth, thereby increasing their appetite for consumer goods and services.
  • INDXX China Infrastructure Index Fund (NYSEARCA:CHXX): This ETF offers targeted exposure to another unique corner of the Chinese market, focusing on infrastructure companies. Among the largest holdings of CHXX are China Railway Construction Corporation (5.1%), Jiangxi Copper Company (5%), and China Telecom Corporation (NYSE:CHA) (5%), highlighting the extent to which this ETF is diversified across various corners of the infrastructure industry.
  • Global X China Financials ETF (NYSEARCA:CHIX): CHIX contains about 25 holdings, all of which are focused in the financials sector. Not surprisingly, CHIX invests in some of the world’s largest financial institutions, and is tilted towards giant and large market capitalization stocks.

Inverse/Leveraged ETFs

For the most risk tolerant of investors, there are a number of inverse and leveraged ETFs that provide an opportunity to amplify exposure to Chinese equity markets:

  • Short FTSE/Xinhua China (NYSEARCA:YXI): This ProShares fund seeks to deliver daily returns equal to the inverse of the FTSE/Xinhua China 25 Index.
  • Direxion Daily China Bear 3x Shares (CZI): This fund seeks daily returns equal to -300% of the change in the Bank of New York Mellon China Select ADR Index, a benchmark made up of companies that have a primary equity listing on a stock exchange in China.
  • Direxion Daily China Bull 3x Shares (CZM): Opposite of the previous ETF, this fund offers 3x daily leverage to the Bank of New York Mellon China Select ADR Index.
  • ProShares Ultra FTSE/Xinhua China 25 (NYSEARCA:XPP): This 2x leveraged ETF is also linked to the FTSE/Xinhua China 25 Index, seeking to deliver 200% of that benchmark’s daily returns.
  • ProShares Ultrashort FTSE/Xinhua China (NYSEARCA:FXP): This ETF is XPP’s bear counterpart, seeking daily results of -200% of the same benchmark.

Real Estate ETFs

With the worlds largest (and increasingly urban) population, China’s real estate markets are often volatile, but have a history of delivering impressive gains. There is one ETF that clears a path for investors to play China’s dynamic real estate sector:

  • Claymore/Alphashares China Real Estate ETF (NYSEARCA:TAO): TAO seeks to replicate the performance of the AlphaShares China Real Estate Index, a benchmark that is designed to measure the performance of the investable universe of publicly-traded companies and REITs deriving a majority of their revenues from real estate development, management and/or ownership of property in China, Hong Kong, and Macau.

Currency ETFs

Given recent events, interest in China’s currency has surged among investors outside of the country; many believe that the yuan could rise as much as 35% against the dollar if a longstanding peg was completely abolished. There are two ETFs offering exposure to China’s currency.

  • Market Vectors-Chinese Renminbi/USD ETN (NYSEARCA:CNY)
  • WisdomTree Dreyfus Chinese Yuan Fund (NYSEARCA:CYB)

Disclosure: No positions at time of writing.

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