Avoid the PowerShares China ETF Due to Reverse Mergers; Buy the iShares China ETF Instead

David Jackson profile picture
David Jackson

Excerpt from our One Page Barron's Summary (receive it by email every week by signing up here):

China Funds' Shell Game By Leslie Norton

Highlighted companies: China Automotive (CAAS), China BAK Battery (CBAK), Comtech Group (COGO), Intac International (INTN), Origin Agri-Tech (SEED), Tiens Biotech (TBV), Wonder Auto (OTCPK:WATG), Zeolite Exploration (ZXPL), and Zhongpin (ZHNP).
Summary: PowerShares argues that its Golden Dragon ETF (PGJ) is a safe way for investors to gain exposure to China because its holds 54 stocks listed on US exchanges (which have strict reporting requirements), in contrast to the iShares FTSE/Xinhua 25 Index ETF (FXI) which holds the 25 largest Chinese stocks listed on the Hong Kong exchange (which has less strict reporting requirements). However, the PowerShares Golden Dragon ETF tracks an index managed by Tim Halter, who runs an advisory company called Halter Financial that specializes in reverse mergers. Chinese companies he has taken public via reverse merger, in return for stock, include Nasdaq-traded China Automotive, Tiens Biotech, and bulletin board-traded China BAK Battery, Zeolite Exploration, Zhongpin, and Wonder Auto. Other reverse-merger stocks in the index include Intac International, Comtech Group, and Origin Agri-Tech. Reverse-merger stocks are subject to manipulation, and the Halter index in particular suffers from conflicts of interest as Tim Halter's firm has sold stocks after inclusion in the index boosted their prices. Members of Mr. Halter's firm claim that that criteria for inclusion in the index are objective and that rules exist to prevent conflicts of interest. The PowerShares Golden Dragon ETF is up 20% this year, considerably trailing the 37% rise of the iShares FTSE/Xinhua 25 Index ETF.
Quick comment: The Barron's article doesn't give much credence to Halter's defense -- that the index constituents are determined by pre-set criteria, so there's no room for manipulation. Perhaps the assumption is that Halter's firm is able to engineer reverse mergers to satisfy those criteria, so potential for, and actual, manipulation still exist. Nonetheless, while the governance issues seem to be of serious concern, the performance disparity of the iShares ETF over the PowerShares ETF may be due to factors other than the inferior performance of reverse-merger stocks, such as the difference in average market cap of the two ETFs and the performance of Hong Kong-listed versus US-listed Chinese stocks.

This article was written by

David Jackson profile picture
I'm the founder and CEO of Seeking Alpha. Before Seeking Alpha, I worked as a technology research analyst for Morgan Stanley in New York. After I left, I wrote The ETF Investing Guide (which you can find by clicking on "Author's Picks" below), and some articles about individual stocks, and then started inviting other people to contribute to the website. Seeking Alpha is now the dominant crowdsourced platform for discussion of stocks and investing, and the only place with coverage of many mid and small cap stocks. I have a B.A from Oxford University and an MSc from The London School of Economics, and am married with five children.
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