Choosing A China Fund

| About: iShares China (FXI)

We are concerned that too many do-it-yourself investors buy funds of all sorts based on the name of the fund without looking closely at what the funds actually own. Some investors would benefit by retaining an advisor to help them understand what they are buying beyond a name.

To show how a little bit of effort can reveal significant differences, let’s look at three China funds: (NYSEARCA:FXI) (by Barclays Global Investors), (NYSEARCA:GXC) (by State Street Global Advisors) and (NYSE:CAF) (by Morgan Stanley Institutional).

All three come up as China funds when you search on popular sites such as ETFconnect. Simply reading the ETFconnect product descriptions starts to give a picture of possible important differences between the funds.

The Fund seeks investment results that correspond generally to the price and yield performance before fees and expenses of the FTSE/Xinhua China 25 Index.

The investment objective of the Fund is to replicate as closely as possible, before fees and expenses, the total return performance of an equity index based upon the Chinese composite market. The Fund uses a passive management strategy designed to track the total return performance of the S&P Citigroup BMI China Index. The Index is a market capitalization weighted index that defines and measures the investments in universe of publicly traded companies domiciled in China, but legally available to foreign investors. The Fund utilizes a sampling methodology in the purchasing the stock to achieve its objective.

The Fund seeks capital growth. The Fund achieve its investment objective by investing, at least 80% of its assets in A-shares of Chinese companies listed on the Shanghai and Shenzhen stock exchanges. The Fund may invest up to 15% of its net assets, in warrants, structured investments or other Strategic Transactions. The Fund is the first U.S. registered investment company that will invest principally in China A-shares. The Fund may also invest up to 20% of its assets in other types of investments, including B-shares of companies listed on the Shanghai and Shenzhen stock exchanges.

From these descriptions we are alerted to the fact that the funds take a different approach.

You see that FXI and GXC seek to replicate the performance of particular but different indices. They are passive. CAF does not seek to replicate the performance of an index. It is active.

FXI invests in a small number of companies and fully replicates the holdings of its benchmark index. GXC seeks to replicate performance through sampling of holdings in its benchmark index which has more constituents than the FXI benchmark index.

FXI and GXC invest in common stocks, whereas CAF can invest in equity securities other than common stocks.

The next thing you need to know is what the benchmark indices or authorized share types are all about:

By going to the FTSE/Xinhua and the S&P Global Indices websites, we can learn first that the full name of the S&P index is S&P/Citigroup BMI China ex A-B Shares Index. Then we learn that the FTSE/Xinhua invests in H-Shares and Red Chip Shares, whereas the S&P Citigroup BMI China ex A-B Shares Index invests in H-Shares, Red Chip Shares, and Chinese companies listed in the United States, Singapore and Japan. We already know from the CAF description that it invests in A-Shares and B-Shares (plus possibly some other types of investments, presumably in China).

The following chart shows graphically that the realm in which each fund invests is not the same:

You may then be challenged by not knowing what A-Shares, B-Shares, H-Shares and Red Chip Shares are.

We do hope that if you are a do-it-yourself investor investing internationally that you already understand American Depository Receipts listed in the United States and Depository Receipts listed elsewhere, such as in Singapore and Japan.

Fortunately, the FTSE/XINHUA site defines the China share types for us, as follows:


Securities of Chinese incorporated companies that trade on the Shanghai or Shenzhen stock exchanges, quoted in Chinese Renminbi [RMB]. Traded by residents of the People’s Republic of China [PRC] or international investors under the China Qualified Foreign Institutional Investors [QFII] regulations.


Securities of Chinese incorporated companies that trade on the Shanghai Stock Exchange (quoted in US Dollars) or the Shenzhen Stock Exchange (quoted in Hong Kong Dollars – HKD). Traded by both non-residents of the PRC and residents with appropriate foreign currency dealing accounts.


Securities of companies incorporated in the PRC and nominated by the Chinese Government for listing and trading on the Hong Kong Stock Exchange, quoted and traded in HKD. Those from the PRC are not allowed to trade H shares however there are no restrictions on international investors.

Red Chip Shares

Securities of Hong Kong incorporated companies that trade on the Hong Kong Stock Exchange, quoted in HKD. The constituents are substantially owned directly or indirectly by the Chinese Government. Those from the PRC are not allowed to trade H shares however there are no restrictions on international investors.

So now we have a clear idea that the three funds don’t pursue the same benchmark, two are passive, one is active, they don’t all buy on the same exchanges, and therefore don’t have full overlap of their investable universe.

Looking at their performance on a site like StockCharts or BigCharts can futher differentiate them.

The strong similarity between the FXI and GXC price curves suggests they may not be much different in practical fact. The CAF price pattern shows it is investing much differently than FXI and GXC.

Looking at portfolio statistics provided by Morningstar we see further similarity between FXI and GXC and differences with CAF.

You can see right away that FXI and GXC have highly similar portfolio statistics, but GXC is a newer fund (less than 1 year versus 3+ years) with far fewer assets, similar but lower expense ratio, and about 4 times as many holdings. CAF is a bit over a year old, has far more assets than GXC, but far less than FXI, and has a much higher expense ratio. CAF has higher valuations in terms of P/B, P/CF and P/E which may or may not relate to correspondingly greater sales and earnings growth rates, but definitely relates to higher expectations, and therefore more vulnerability to disappointment.

Next you might go to Morningstar and examine the actual portfolios of the three funds to see how much overlap exists.

You notice that FXI and GXC have substantial overlaps in their key holdings, even though GXC has four times the total number of holdings. You also notice that the key holdings CAF have little overlap with the key holdings of the other two funds.

Next, you might go to a site such as Yahoo Finance to see how liquid the funds are for ease of entry and exit. You see that GXC and CAF have similar 3-month average daily dollar value of shares traded, but that FXI has 60-70 times the average daily volume of either of the other two funds.

If the funds were older you could go to sites such as Morningstar or Index Universe and compare their volatility (standard deviation of return) and risk adjusted returns (Sharpe Ratios), and other data that require some maturation of results.

You can find a shorter-term view of volatility as a measure of risk at the RiskGrades site which measures volatility against a global basket of stocks. If you did that for the three funds we are examining here, you would find that GXC is less volatile (risky) than FXI, and that CAF is substantially more volatile (risky) than either FXI or GXC.

There is certainly more that you could do to determine which fund is best for your purposes and situation, such as read the prospectus, but in as little as 30 minutes or less you could determine all that we have covered in this article.

We aren’t particularly recommending China funds here, just using them to illustrate how much you can learn from public internet sources in a very short period of time.

Considering how long you had to work to earn the money you invest, it is a good idea to spend a little more time (or to invest an advisory fee) to learn enough about your fund choices to make informed decisions.

We think that much research would be a good investment for every fund type you decide to purchase.

Good hunting.