Stocks Rally After Chinese New Year; May Be Time to Look at Chinese ETFs

Chinese stocks have been rallying following the week-long Lunar New Year break. Stocks on the benchmark Shanghai Composite Index (SCI) have rallied in six straight sessions and are holding above 2,900, up 4.2% this year, which is encouraging given the poor start. 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 Chinese growth stocks, especially those of the small-cap variety. You could also play China via some good exchange-traded funds (ETFs). Chinese stocks have been rallying following the week-long Lunar New Year break. Stocks on the benchmark Shanghai Composite Index (SCI) have rallied in six straight sessions and are holding above 2,900, up 4.2% this year, which is encouraging given the poor start. 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 Chinese growth stocks, especially those of the small-cap variety.

According to Japan, China’s nominal gross domestic product (GDP) of $5.87 trillion in 2010 has surpassed Japan’s nominal GDP of $5.47 trillion. Only the U.S. is ahead.

While the risk is high in trading Chinese stocks, especially of the small-cap variety and for smaller trading accounts, you could also play China via some good exchange-traded funds (ETFs).

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

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As an example of a blue-chip focus, take a look at the iShares FTSE/Xinhua China 25 Index Fund (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 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.

With $6.87 billion in assets as of February 16, the FXI ETF has delivered solid results since its launch on October 5, 2004. The current yield on the FXI ETF is 1.71%.

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 February 15 include financial services (47.37%), telecommunications (18.66%), energy (16.64%), basic materials (9.88%), and industrial (5.81%).

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 February 15 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 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 underperformance over the last five years.

Based on the net asset value (NAV), the FXI ETF has a five-year return of 17.77%, versus 18.3% for the group. For the last six months, the FXI is up 8.28%, compared to 8.68% 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 below average based on a 0.54 beta versus the S&P 500.