Get Alternative With Your China ETF Strategy

by David Fabian | October 10, 2013 1:11 pm

While most domestic equity indices are notching red-hot returns in 2013, India, Brazil and China ETFs focusing on large-cap BRIC companies still are struggling in the red.

Much of this underperformance can be blamed on slowing economic growth combined with currency devaluations that have dragged their markets lower.

China in particular has seen a slowdown in its financial and real estate sectors, which has weighed on the widely held iShares China Large-Cap ETF (FXI[1]). This China ETF has more than 55% of its $5.7 billion in assets invested in companies that are tied to these sectors. The overweight nature of this asset allocation has led to FXI posting a total return of -4.7% so far this year.

Amid FXI’s troubles, several China ETF alternatives might prove more worthy of your hard-earned dollar.

HAO: A China ETF for Small-Cap Stocks

One alternative China ETF opportunity that has flown largely under the radar this year is the Guggenheim China Small Cap ETF (HAO[2]).

HAO, which is comprised of 251 small-cap stocks centered in China and Hong Kong, has just more than $200 million in total assets.

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For inclusion in the ETF, Guggenheim defines small capitalization companies as those with a maximum $1.5 billion market cap. The top three sectors include industrials, financials and consumer discretionary stocks, which together make up roughly half of the ETFs underlying portfolio.

Small-cap stocks are an excellent way to get exposure to growing segments of the economy that are often overlooked because of their relative obscurity. Many people believe the next phase of China’s growth will be stimulated by local consumers instead of foreign exports, which are what small-cap holdings such as Youku Tudou (YOKU[3]), Sohu (SOHU[4]) and others are uniquely positioned to reach. In addition, with HAO you avoid many of the mega-cap China stocks that are dominated by state-run enterprises.

HAO is trading very near its 52-week highs and has been in a strong uptrend since its June lows. Net expenses for HAO are 0.75% annually, or $75 of every $10,000 invested.

PGJ: A China ETF for Tech Stocks

One of the best performing segments of the Chinese economy this year has been technology stocks. The Guggenheim China Technology ETF (CQQQ[5]) is comprised of a concentrated 39 companies in the information technology field. The ETF only has $39 million in assets, but it has posted an impressive gain of more than 50% so far in 2013.

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A slightly larger and more diversified play in this arena is the PowerShares Golden Dragon China Portfolio (PGJ[6]). This fund is comprised of small-, mid- and large-cap stocks in the China region, but has an overwhelming 56% allocation to technology stocks such as travel site (CTRP[7]) and search stock Baidu (BIDU[8]). This overweight exposure has helped boost PGJ to gains similar to CQQQ’s at 50%-plus.

One of the reasons I like this China ETF is that you get exposure to multiple sectors in a package that is overweight high-growth companies. However, based on the tremendous rise during the past six months, I would be wary about adding money to PGJ near the highs[9]. I would prefer to wait for a modest pullback before adding Golden Dragon China Portfolio to enhance your odds of a successful long-term holding.

Bottom Line

Remember that stocks in China will likely be more volatile than their domestic counterparts, so use a trailing stop-loss[10] to lock in gains or protect new positions. In addition, I always recommend thoroughly researching[11] the underlying companies and sectors within any ETF to know what you own and how a fund stacks up against its peers.

David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Learn More: Why I love ETFs, And You Should Too[12].

  1. FXI:
  2. HAO:
  3. YOKU:
  4. SOHU:
  5. CQQQ:
  6. PGJ:
  7. CTRP:
  8. BIDU:
  9. near the highs:
  10. use a trailing stop-loss:
  11. recommend thoroughly researching:
  12. Why I love ETFs, And You Should Too:

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