A Safer Way to Invest in China: The Large-cap Chinese ETF

Playing the Chinese capital markets involves excessive political and economic risk. While the risk is high in trading Chinese stocks, especially of the small-cap variety and for smaller trading accounts given the current selling of Chinese reverse merger stocks, there's another, lower risk way you could play China.The Shanghai Composite Index (SCI) has been rallying. It is up 8.37% this year as of April 14, well above the comparative gains of the NASDAQ, DOW, Russell 200, and S&P 500.

But playing the Chinese capital markets involves excessive political and economic risk. However, my investment advice is that you should build a well-diversified portfolio that would enable you to play Chinese growth stocks, especially those of the small-cap variety.

China is the second largest economy in the world and is continuing to roll along at a nice pace. The International Monetary Fund (IMF) estimates that the U.S. will grow its GDP by 2.8%, this year compared to a stellar 9.6% for China.

While the risk is high in trading Chinese stocks, especially of the small-cap variety and for smaller trading accounts given the current selling of Chinese reverse merger stocks, you could also play China via some good exchange-traded funds (ETFs). This way, you can minimize the risk to your capital.

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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 companies that you would otherwise be unable to get access to easily, 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.

With $7.96 billion in assets as of March 31, 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 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 has no software or hardware stocks. The five top sectors as of March 31 include financial services (51.38%), telecommunications (16.65%), energy (15.49%), basic materials (12.74%), and industrial (3.75%).

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 China.

The 10 top holdings are China Mobile, China Construction Bank, Industrial And Commercial Bank of China, CNOOC, China Life Insurance, China Unicom, China Petroleum & Chemical, Petrochina, China Telecom, and Bank of China.

As far as its comparative performance goes, 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 has been some underperformance over the last five years.

Based on the net asset value (NAV), the FXI ETF has a five-year return of 14.31% versus 10.49% for the group. For the last three months, the FXI is up 4.22%, compared to negative 1.18% 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 0.96 beta versus the group.