How to Play China with Less Risk

Playing Chinese stocks and capital markets involves great political and economic risk. Tips from George Leon on how to play China with less risk.Chinese stocks continue to be in the dumps compared to the rally in U.S. stocks. The benchmark Shanghai Composite Index (SCI) is firmly in the red this year, down 13.28%. However, the plus is that Chinese stocks are no longer trapped in a bear market.

My Chinese stocks I cover in my newsletter China Investment Letter are struggling, but I continue to be long-term bullish on China and the Chinese economy. However, watch for the short-term volatility.

Playing Chinese stocks and capital markets involves great political and economic risk. However, as I have said, a well-diversified portfolio will enable you to play Chinese stocks, especially those of the small-cap variety.

The Chinese economy continues to grow at over nine percent, but it’s down from over 10% in 2010. This does not mean that the Chinese economy is set for a hard landing as some pundits would want you to believe, but this amount of growth is impressive.

The risk for many of you is to minimize the risk of buying small Chinese stocks. You can do this by buying exchange-traded funds (ETFs).

In the funds area, I like the Dreyfus Premier G China (DPCRX) mutual fund and the PowerShares Golden Dragon Halter USX China (AMEX/PGJ) ETF. The Dreyfus and PowerShares have strong small-cap Chinese stocks components.

If you are looking for more of a blue-chip focus to play the growth of the Chinese economy, take a look at the iShares FTSE/Xinhua China 25 Index (NYSE/FXI). The fund holds the top major companies in China. Holding this fund allows you to own large blue-chip Chinese companies that will benefit from the Chinese economy, which you would otherwise would unable to easily get access to unless you trade Asian markets.

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.

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

The FXI ETF contains no technology stocks, but focuses on companies that benefit from a growing Chinese economy. The four top sectors as of September 30 include financial services (46.17%), energy (19.04%), telecommunications (19.41%), and basic materials (13.69%). 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, especially given the decision to slow down lending in the Chinese economy.

The fund started out strong, but has been struggling. Based on the net asset value (NAV), the FXI ETF has a five-year return of 4.50% versus 8.08% for the group. Year-to-date, the fund is underperforming, down 27.29% versus -12.19% for its peer group.

If the fund can turn its fortunes and the Chinese economy doesn’t tank, the FXI ETF may work for more conservative investors looking for some blue-chip Chinese stocks.

If you want to know why I do not believe a hard landing is in store for China, read China’s Economic Landing: Hard or Soft?

Read about why Chinese reverse merger stocks are dead but could improve with the move towards cleaning up the listing process in Market Risk Dries up IPO and Reverse Mergers Pipelines.