Tuesday, 27 October 2009

Investing in China: Four ETFs Compared

Have you become interested in investing in the People's Republic of China after reading that it is now the world's third largest economy on a path to grow larger than Japan's economy within five years, and that it is recovering fastest from the 2008 crash and recession?

While there are a number of emerging markets funds that have China represented within, we'll look at the four main ETFs devoted only to China. All are broad equity market passive index ETFs, i.e. they simply buy what the index contains and do not try time to time or outperform the market. All trade in the USA - and thus in US dollars (USD) - on the New York Stock Exchange.

Four China Equity ETFs:
iShares:FTSE/Xinhua China 25 Index Fund (Symbol: FXI)
iShares MSCI Hong Kong Index Fund (EWH)
PowerShares Golden Dragon Halter USX China Portfolio (PGJ)

Comparing the Four in Detail

FXI is the giant, with by far the most net assets, which makes it highly liquid with the lowest buy-sell spreads (i.e. if you buy or sell at market you are going to get the best price). It is the mega cap fund (the average market cap of its constituent companies is $78 billion - by contrast that of the TSX 60 largest companies in XIU is only $9 billion). FXI is not very diversified, with only 25 companies and is it quite concentrated in the financials, which occupy about half its portfolio. Technology is totally absent from the holdings and consumer companies are an inconsequential amount, which is a great surprise given the country's huge consumer export sector. Nevertheless, FXI has had the best performance since 2007, along with GXC (see chart below). FXI also has the highest MER fees at 0.74%

EWH has more holdings than FXI but is even more concentrated in one sector, with almost two-thirds of its investments in financials. It represents Hong Kong and not the mainland. There is no significant overlap with the other ETFs - none of the top ten holdings are the same. EWH holds the smallest size companies of the four ETFs. Its performance price track has also been notably different and weaker than the other three ETFs but it has been much less volatile. It has the lowest MER at 0.52%.

PGJ is unusual in that it only holds companies whose securities are listed in the USA (whose stricter reporting regulations may therefore entail better quality and more reliable published results), though they must derive the majority of their revenue from China. It is well diversified with holdings in 120 companies, its largest sector holding being in technology, which is weak or absent from both FXI and EWH.

GXC would appear to be a well-designed fund, with the broadest diversification of 125 companies and a good balance between many sectors, though the top ten holdings still make up half the market value of the ETF. It has a reasonably low MER of 0.59% too. But GXC trading volume is the lowest of the lot, just barely reaching the 100,000 shares per day that many consider the minimum to achieve acceptable buy-sell pricing spreads and liquidity.

The GXC index objective to buy into the companies "foreigners are allowed to purchase" reveals an important fact - most Chinese companies are not available for various reasons. The Shanghai Stock Exchange includes about 860 companies according to Wikipedia. Any of the four ETFs suffers from this limitation on how extensively a Canadian investor can buy into the Chinese growth story.

The gyrations of the ETFs since 2007 have been considerable, as the chart image from Google Finance shows. All the China ETFs have been much more volatile than the TSX.

The chart also demonstrates that despite their different weightings, FXI and GXC seem to track each other very closely. The similarity and dominance of their respective top ten holdings probably accounts for this fact.

Currency Effects - Beneficial up to now, but ...
None of the ETFs hedges against shifts of the Chinese currency, the renminbi (symbol RNY). Exposure to foreign currency is one of the diversifying benefits of international investing. The already strong performance of FXI from November 2004 to July 2009 was boosted even more for the Canadian investor when the USD to CAD conversion factor is applied. Of course, there is no guarantee that will continue in future. There are periods when currency will move against the investor and reduce or eliminate foreign market gains.

Which ETF is best? My favorites are the more broadly diversified GXC and PGJ but none stands out as ideal in every way. This is not an investment recommendation and you have to make your own choice.

1 comment:

Toronto real estate agent said...

Many people (in concrete those with more than 1,000$ on bank account) are dealing with the idea to invest in China. Yes, I know that economy of this country follows very prospering trend...but I think, not everything is anouut money...do we forget about conditions people live in? That this country does not accept basic human rights?
Sooo, that is my point of view,