Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

This Large-cap Chinese ETF
Ideal for Long-term Investors

Friday, April 27th, 2012
By for Profit Confidential

Chinese stocksThe Shanghai Composite Index (SCI) has been rallying and is up 9.3% this year as of Thursday, which is ahead of the Dow Jones Industrial and just below the S&P 500.

However, playing the Chinese capital markets involves excessive political and economic risk. The country is also stalling, but continues to grow well above other global regions, including Europe and the eurozone. My investment advice is that you need to build a well-diversified portfolio that would enable you to play Chinese growth stocks, especially small-cap stocks.

China is the second largest economy in the world and is continuing to roll along at a nice pace in spite of the country’s gross domestic product (GDP) slowing to 8.1% in the first quarter, down from 8.9% in the fourth quarter. The International Monetary Fund (IMF) estimates that the U.S. will grow its GDP by around 2.5% this year, compared to around 8.5% for China.

While the risk is high in trading Chinese stocks, especially of the small-cap variety and for smaller trading accounts given the selling of Chinese reverse merger stocks over the past year, you could also play China via some good exchange-traded funds (ETFs). If you are looking for some Chinese Internet plays, find out which stocks are the most interesting in Surfing China’s Internet for Profits.

In the ETF area, I like the PowerShares Golden Dragon Halter USX China ETF (AMEX/PGJ), which has strong small-cap components.

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. Holding this fund allows you to own large blue-chip Chinese stocks you would otherwise be unable to easily get access to unless you trade Asian markets.

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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 $6.10 billion in assets as of March 31, the FXI ETF has delivered relative good results since its launch on October 5, 2004. The current yield on the FXI ETF is 2.07%.

The FXI ETF has a large-cap focus, making it more suited to conservative investors, albeit even more speculative investors should have some large-cap holdings in their portfolios for diversification purposes and should avoid having all of their holdings focused in an area.

The FXI ETF has no software or hardware stocks. The five top sectors as of March 31 include financial services (52.70%), telecommunications (18.65%), energy (14.90%), basic materials (12.93%), and industrial (0.82%).

The top four holdings have been the same since the start of 2010, so you get a sense of what areas the fund likes. The large financial portion presents a higher-risk element.

The 10 top holdings are China Mobile, China Construction Bank, Industrial And Commercial Bank of China, CNOOC, Bank of China, China Life Insurance, China Telecom, China Merchants Bank, China Shenhua Energy, and Petrochina.

The average price-earnings multiple is 8.92X and trading at 1.30X book value and 1.25X sales, which indicates conservative blue-chip stocks. This index is similar to the DOW.

As far as the comparative performance, the FXI ETF has done well versus its peer group, which is defined as the Asia-Pacific region, excluding Japan. The longer-term results have been fairly good, but there have been some under performance over the last five years.

Based on the net asset value, the FXI ETF has a five-year return of 3.06% versus 3.74% for the group.

The FXI ETF may work for more conservative investors looking for some blue-chip Chinese stocks. You should have a longer-term perspective due to the above-average volatility. The risk of this ETF is below average based on a 0.90 beta versus the group.

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George Leong - Financial Planner, ConsultantGeorge Leong, B. Comm. is a Senior Editor at Lombardi Financial, and has been involved in analyzing the stock markets for two decades where he employs both fundamental and technical analysis. His overall market timing and trading knowledge is extensive in the areas of small-cap research and option trading. George is the editor of several of Lombardi’s popular financial newsletters, including The China Letter, Special Situations, and Obscene Profits, among others. He has written technical and fundamental columns for numerous stock market news web sites, and he is the author of Quick Wealth Options Strategy and Mastering 7 Proven Options Strategies. Prior to starting with Lombardi Financial, George was employed as a financial analyst with Globe Information Services. Add George Leong to your Google+ circles