A Good Way to Enjoy the Chinese Play

by George Leong, B. Comm.

The Shanghai Composite Index (SCI) was up over 80% earlier in the year, but corrected 20% recently. It is now hovering around a 3,000 key level. Someone recently asked me if it was a good time to dive in and buy Chinese stocks. My feeling is to be cautious and only buy small amounts, as the SCI remains vulnerable to high downside risk.

The reality is that playing the Chinese capital markets involves excessive political and economic risk. The Chinese government could easily come in and change regulations with no issue. It is a one-state controlled economy and this is important, since it adds higher risk.

Yet, as I have said quite often, you need to be well diversified, which would enable you to play some Chinese growth stocks, especially those of the small-cap variety.

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If you do not want to buy specific stocks, you can still play the Chinese market via Chinese exchange traded funds (ETFs). This would allow you participation in Chinese-listed stocks in a basket.

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.

Both the Dreyfus and Powershares 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 $11.3 billion in assets as of August 31, 2009, the FXI ETF has delivered solid results since its launch on October 5, 2004. The current yield on the FXI ETF is 1.36%. The total expense ratio is 0.74%.

The FXI ETF has a large-cap focus and hence would be more suited to conservative investors, albeit even more speculative investors should have some large-cap holdings in their portfolio for diversification purposes. The ETF’s average P/E is 14.57X. About 92.59% is invested in stocks.

The FXI ETF has no software or hardware stocks. The five top sectors (as of August 31) include financial services (49.40%), telecommunications (17.60%), energy (16.58%), industrial (11.49%), and business services (2.71%). The large financial portion does present a higher-risk element.

The 10 top holdings as of August 31 are Bank of China, Bank of Communications, BOC Hong Kong, China Construction Bank, China Life Insurance, China Mobile, China Shenhua Energy, CNOOC, Industrial and Commercial Bank of China, and PetroChina.

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 three-year return of 16.58% versus 6.16% for the group. For the last three months, the FXI gained 35.32%, compared to 11.16% for the group.

For those of you looking for some red-chip holdings, but who may not want to have to select stocks, 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 1.31 beta versus the comparative index.