China ETF Investment Choices: PGJ and FXI

Includes: CHN, FXI, PGJ
by: David Fry

Prior to the introduction of US-based and China-linked ETFs, investors looking to capitalize on China’s booming economy struggled to find appropriate and rewarding investment vehicles. Hong Kong listed companies and mutual funds like the China Fund (ticker: CHN) were the primary choices.

The rapid expansion of single-country ETFs has broadened investor options. Barclay’s was first to introduce a China ETF, FXI, based on the the Xinhua 25 Index featured in London. In analyzing FXI, I found that it closely tracks EWH (Hong Kong ETF) performance. This isn’t surprising since most of its constituent stocks are also duplicated in EWH and the Hang Seng Index. EWH continues to experience more than twice the daily volume (500K vs. 250K) of FXI. Despite this differential, both are finding adequate liquidity. It’s not uncommon for investors to continue to trade what they’re accustomed to and rival ETFs often find gaining acceptance more difficult.

More recently, the AMEX listed an ETF, PGJ, based on the Halter USX China Index.

Unlike EWH or FXI, PGJ features only those companies that trade as ADRs (American Depository Receipts). Only roughly 45% of the constituent stocks included within FXI are also traded as ADRs. This means that investors will have more assurances that the constituent stocks within PGY have met the more stringent listing requirements within the US.

Further, all companies involved within PGJ must be doing a majority of their business within China. EWH and FXI include many Hong Kong companies where their real estate component is an important aspect of their valuation. Most companies included in FXI are former state owned and operated enterprises. Many investors have avoided these former state enterprises (typically traded as "B Share" listings in Shanghai) as accounting and financial disclosures of these enterprises struck many experienced investors as dubious and not verifiable. PGJ possesses less of this stigma.

More importantly, PGJ constituent companies have a much more dynamic business mix to include technology, manufacturing, transportation, and insurance. In fact, many of the stocks in the index have been prominently featured as big-movers over the past few years. These include internet darlings SINA and NetEase; insurance giant, China Life; and of course, auto manufacturer, Brilliance China.

Unfortunately for PGJ, since its recent issuance in early December, its unique features are still undiscovered by investors versus either EWH or FXI as evidenced by trading volume averaging only 80K shares per day. I believe this will change in time.

Editor's Update: Since this article was published, more China ETFs have come to market. You can find a list of them here: China (and other single country emerging market) ETFs.