Here’s the Best Way to Buy Chinese Stocks

It might not seem like the conversation to have right now. After all, in the span of less than two months, investors have been treated to a dramatic collapse in China A-shares and a devaluation of the yuan.

China chinese stocks MapOn their own, the repudiation of the stocks trading on China’s mainland and the yuan devaluation underscore the risks and volatility investors face when perusing China for opportunity. By some measures, China is the world’s largest economy, and with that heft comes an ample number of ways for U.S. investors to access the market.

There are nearly 160 China-based companies trading on a major U.S. stock exchange, such as the Nasdaq or New York Stock Exchange, according to Finviz data, and that number does not include myriad Chinese penny stocks that have been relegated to over-the-counter and pink sheets trading.

While there can be allure in picking individual Chinese stocks, such an endeavor hasn’t been very rewarding this year — at least not with some of the marquee names that investors are most familiar with.

Shares of Alibaba (BABA) are off 33% year-to-date, while previously beloved Baidu (BIDU) is lower by roughly the same amount. Don’t be fooled into thinking China’s state-owned enterprises (SOEs) have been much better. As just one (admittedly glaring) example, PetroChina (PTR) has tumbled 24% this year.

For many investors, exchange-traded funds are practical avenues for accessing Chinese stocks. Though this route is valid, investors still face a dizzying array of choices as there are more than 260 ETFs with at least some exposure to Chinese stocks.

The number of China-specific funds is significantly smaller, though not too small, and the number is growing. However, the number of China ETFs that can be considered “large” or “major” is, well … pretty small. Still, this select group of funds is where ETF investors typically concentrate their efforts when it comes to China.

How to Invest in Chinese Stocks

The SPDR S&P China ETF (GXC) is our  nominee for the best way to invest in China. While past performance is not indicative of future returns, the performance of the SPDR S&P China ETF ranks highly among China ETFs.

Over the past three years, GXC has topped the iShares China Large-Cap ETF (FXI), the largest China ETF trading in the U.S., by nearly more than two percentage points while being less volatile. In other words, GXC has presented investors with a more favorable risk/reward scenario than the larger FXI.

Of course past performance is in the past, so investors need to assess GXC’s other merits before committing capital to the fund. One positive trait with GXC is its broad-based exposure to Chinese equities. The ETF offers exposure to China H-shares, China Red Chips, China P-Chips and China American depositary receipts (ADRs).

The one thing missing from that bit of alphabet soup is A-shares. The absence of A-shares is a drawback for GXC when ETFs like the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) are surging, but ASHR has also been nearly two-and-a-half times as volatile as GXC over the past three months.

Plus, a bet on the A-shares ETFs is a bet on China’s most richly valued stocks. Conversely, GXC’s lineup of primarily Hong Kong- and U.S.-listed fare trades at a discount. The ETF’s P/E ratio of just below 11 is slightly below that of MSCI Emerging Markets Index and well below that of the S&P 500.

Remember, one of GXC’s selling points is its broad-based exposure to Chinese stocks. Translation: The ETF holds 363 stocks, or more than seven times the number of holdings found in FXI. For some reason, professional investors have largely preferred FXI, an ETF with just 50 holdings as a means of accessing the world’s second-largest economy. That preference is even more inexplicable considering GXC’s long-term outperformance of the 50-stock ETF.

Like rival China ETFs, GXC is dominated by financial services stocks. The sector is over one-third of the ETF’s weight, but even that is light compared to FXI. Also, GXC’s relatively slight energy sector exposure (just 6.5%) tempers the ETF’s exposure to state-owned companies. GXC’s sector advantages include a combined weight of nearly 29% to technology and consumer discretionary names, sectors that are not usually represented enough in rival China ETFs.

Another perk with GXC: Its annual expense ratio is 0.59% or $59 per $10,000 invested, compared to an average expense ratio of 0.63%, $63 per $10,000 invested, on all China ETFs.

All in all, it’s hard to find a more attractive way to play Chinese stocks than the GXC.

As of this writing, Todd Shriber did not hold a position in any of the aforementioned securities.

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