A Way to Play Some Chinese Growth Stocks

chinese growth stocksOur Chinese stock recommendations have been rallying and continue to show some strong gains. I remain long-term bullish on China, but you should watch for the short-term volatility.

On the chart, the Shanghai Composite Index (SCI) has rallied back above the key 3,000-point level — the second straight day in which it broke 3,000. The previous time the SCI was above 3,000 was on April 23. The index has gapped higher. It is above its 200-day moving average (MA) of 2,921, along with its 20-day and 50-day MAs, which is bullish. The SCI broke higher out of its previous sideways channel between 2,575 and 2,700. Watch to see if the SCI can hold at 3,000. The MACD is bullish and the Relative Strength is strong, so there could be additional gains.

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

In the funds area, I like the Dreyfus Premier G China (DPCRX) mutual fund and the PowerShares Golden Dragon Halter USX China ETF (AMEX/PGJ). Both Dreyfus and PowerShares have 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 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.

With $8.53 billion in assets as of September 30, the FXI ETF has delivered solid results since its launch on October 5, 2004. The current yield on the FXI ETF is 1.59%.

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 September 30 include Financial Services (45.86%), Energy (20.54%), Telecommunications (17.89%), Industrial Materials (7.95%) and Business Services (4.05%). 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 as of October 18 are China Mobile, China Construction Bank, Industrial and Commercial Bank of China, CNOOC, China Life Insurance, China Merchants Bank, Bank of Communications, Bank of China, China Petroleum & Chemical, and China Unicom.

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 good, but there has been some underperformance over the last three years.

Based on the net asset value (NAV), the FXI ETF has a five-year return of 16.94% versus 11.67% for the group. Year-to-date, the fund is underperforming, up a mere 2.46% versus 10.62% for its peer group. For the last three months, the FXI is up 9.43% compared to 19.94% for the group.

If the fund can turn its fortunes, 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 potential above-average volatility. The risk of this ETF is above average based on a 1.13 beta versus the S&P 500.