How to Capitalize on the Growth in China

“Calling the Trend Column,” by George Leong, B. Comm

A friend of mine is in China for a month doing some work. He said that he is amazed by the rate and scope of the development in the country’s economic development zones. Wherever he goes, there is something being built.

In my view, China offers such incredible investment opportunities. Plus there’s the fact that China is a neighbor of the world’s second most populous country, India, where there are also fantastic opportunities, with over 1.1 billion people and excellent growth prospects. Imagine the combined markets when the disposable incomes in both countries rise upwards. China and India are working on numerous co-trading ventures that would drive up the GDP of both countries going forward. With a third of the world’s population in China and India, there are massive opportunities for growth there. It may take some time to drive up the countries per capita, but it is happening.

The benchmark Shanghai Composite Index (SCI) is holding above 3,000, but it is down about eight percent this year. The recent correction was driven by concerns of a real estate and credit bubble forming in China and the decision of the Chinese government to halt lending by banks. It’s feared that the action will hurt economic growth in China, but, at the same time, it may be the right move to avoid a financial collapse in the country. We feel that the fact the SCI is holding at 3,000 reflects the support for the move.

Yet, for some, the reality of playing the Chinese capital markets involves excessive political and economic risk. Yet, as I have said, you need to be well diversified, which would enable you to play some Chinese growth stocks, especially those of the small-cap variety.

If you are more risk-adverse, you may want to look at Chinese funds or ETFs.

In the funds area, we like Dreyfus Premier G China (DPCRX)
mutual fund and the PowerShares Golden Dragon Halter USX China ETF (AMEX/PGJ). Both the Dreyfus and PowerShares funds have strong small-cap components, but if you are looking for more of a blue-chip focus, take a look at the iShares FTSE/Xinhua China 25 Index (NYSE/FXI), which holds the top major companies in China.

The ETF is based on the Xinhua 25 Index, consisting of 25 of the largest and most liquid Chinese stocks. The FXI ETF is a relatively conservative play on Chinese stocks.

With $8.1 billion in assets as of January 31, 2010, the FXI ETF has delivered solid results since its launch on October 5, 2004. The current yield on the FXI ETF is 1.41%. The total expense ratio is 0.73%.

The FXI ETF has a large-cap focus and hence would be more suited to conservative investors, although even more speculative investors should have some large-cap holdings in their portfolio for diversification purposes.

The FXI ETF has no software or hardware stocks. The five top sectors (as of January 31) include financial services (46.89%), energy (20.26%), telecommunications (16.65%), industrial materials (8.25%), and consumer goods (3.16%). The large financial portion does present a higher-risk element, especially given the recent decision to slow down lending in China.

The 10 top holdings as of January 31 are Bank of China, China CITIC Bank, China Construction Bank, China Life Insurance, China Merchants Bank, China Mobile, China Shenhua Energy, CNOOC, Industrial and Commercial Bank of China, and Ping An Insurance Group Co. of China.

Performance-wise, the FXI ETF has done well versus its peer group, defined as the Pacific/Asia excluding Japan. Based on the NAV (net asset value), the FXI ETF has a five-year return of 20.43% versus 10.59% for the group. Year to date, the fund is up 52.33% versus a 7.79% loss for its peer group. For the last three months, the FXI is up 5.32% compared to a 0.6% loss for the group.

Those of you looking for some red-chip holdings, but who may not want to have to select stocks, should take a look at the FXI ETF. You should have a longer-term perspective due to potential above-average volatility. The risk of this ETF is above average based on a 1.28 beta versus the S&P 500.