Tuesday 7 September 2010

ETF Comparison: Three New China ETFs for Canadian Investors

The economies of the USA, Europe and even Canada may be struggling to avoid a double dip recession but that of China is powering forward with recent annualized growth of over 10%. The case for investing in China as a separate individual country holding becomes more compelling every day. It is now acknowledged to be the world's second largest economy (see Wikipedia article on China's economy) and there is a school of thought e.g. this academic paper that it will eventually eclipse even that of the USA. The investment view is generally bullish as is seen in a couple of other backgrounders on China: Investment Strategies for the China Century from Claymore Canada and Will China, India and Gold Lead the Recovery? from BMO ETFs in February 2010.

As investor interest in China grows, so do the ETFs available. Last year we posted on US-traded China ETFs - Investing in China: Four ETFs Compared. Since the start of 2010, three new ETFs trading in Canada on the TSX have appeared so let's review them.

iShares China Index Fund (symbol: XCH)
XCH is the Canadian version of the iShares China ETF sold in the USA under the symbol FXI. In fact, XCH holds only FXI. XCH's management fee (MER) is a bit higher at 0.85% vs 0.74% for FXI. XCH has the highest MER of the three new ETFs.

To repeat the previous review of FXI, a key characteristic and drawback of XCH is the relative lack of diversification - few holdings in total with only 25 stocks in the portfolio. For more, read the excellent Morningstar Analyst Report by John Gabriel (free registration required) of July 27, 2010.

Claymore China ETF (Symbol: CHI)
The newest ETF kid on the block, CHI is barely a month old. Like XCH, it is a Canadian clone of a US-traded ETF, in this case Claymore's fund under the symbol YAO. As opposed to XCH/FXI, Claymore charges the same MER of 0.70% in Canada on CHI as it does in the US.

CHI is a well-diversified fund with a good number of holdings - 150, the most of any China ETF including all the previously reviewed US ETFs. CHI also deliberately spreads out its allocation across sectors and individual companies through its policy limit of a maximum 35% in any industry sector and 5% in any company. For more on CHI/YAO, read the Seeking Alpha article YAO: Eight Reasons to Watch New Claymore China ETF.

As with all its funds, Claymore offers automatic no-commission dividend reinvestment (DRIP), pre-authorized chequing contributions (PACC) and systematic withdrawal e.g. for retirees (SWP). These features save commission costs.

BMO China Equity Hedged to CAD Index ETF (symbol: ZCH)
ZCH's unique characteristic is the hedging of the Chinese currency against the Canadian dollar to remove the effects of currency swings on the investment performance of the ETF. However, hedging costs money and the fund, not the manager, pays the cost. Though it remains to be seen with ZCH, hedging cost typically manifests itself in under-performance against the index. It is too early to tell how well the ETF managers will do the job and how much return loss there may be in exchange for the currency protection. Currency is a double-edged sword for investors. It can accentuate or overwhelm the actual foreign market return, either to the investor's benefit or detriment, as we have discussed previously in The Historical Effect of Inflation and Currency on a Canadian Investor's International Portfolio and Foreign Investments: to Hedge or Not to Hedge Foreign Currency.

ZCH's management expense ratio is the lowest of three funds at 0.65%. Its diversification lies between XCH and CHI - it holds 42 stocks, spread across all sectors. As one of the BMO ETF family it also offers an optional DRIP for investors.

Key Differences Between the ETFs
1) Sector and Stock Weightings, Not Holdings: Despite using different indices, the main holdings of the three funds overlap to a significant degree. For example, in the top ten holdings XCH and CHI have 6 stocks in common, XCH and ZCH share 5 stocks and ZCH and CHI share 6 stocks. It is the stock and sector weightings that will be more important to eventual differences in investment performance of the three ETFs.
  • XCH has a high percentage (60%) of the total portfolio represented by the top ten stocks, heavy concentration in financial sector stocks and no holdings at all in the Technology sector
  • The top ten holdings make up only 43% of CHI, which is the lowest concentration of any China ETF. CHI has an appreciable allocation of 11% to Technology stocks.
  • ZCH has by far the highest weighting (22%) of any of the funds in the Technology sector and the lowest in Financials (only 9% vs 32% in CHI and 47% in XCH).
2) Currency Exposure vs Hedging: ZCH's policy to hedge exposure to the Chinese currency (note that it is the Chinese Yuan exposure that is at issue not the US dollar, even when the holdings of XCH and CHI consists of US-traded securities - see CanadianFinancialDIY's Clarification of Foreign Exchange Risk on International ETFs) may end up being good or bad but it will surely cause ZCH's returns to differ, probably markedly from those of XCH and CHI. In the month of August alone, the price path of ZCH has differed markedly from that of XCH and CHI as the Google Finance chart below shows.

There has been much pressure on China to let the yuan rise in value (see NuWire Investor's How China's Currency Policy Change Could Impact the US Economy) and if that comes to pass, it will increase returns on Chinese stocks for Canadian investors. On the other hand, in the past year, the Yuan has depreciated 5% against the Canadian dollar (according to the RatesFX Visualization chart for Yuan), which has reduced net returns for Canadian investors.

Detailed Comparison Table of ETF Features and Characteristics

The Canadian-Traded vs the US China ETFs - Factors to Consider
  • Currency Conversion: For the Canadian investor, ETFs traded in Canada offer the convenience of dealing only in Canadian dollars. Most online brokers still do not offer the possibility to hold US dollar cash in registered accounts so trading in Canada avoids the necessity to incur currency conversion costs (which average around 1% per conversion of the amount converted). The frequency of buying or selling accentuates this factor. For non-registered accounts, tax reporting will be easier for the Canadian funds as the conversion results will show up on T-slips and capital gains ACB calculations will be simpler.
  • Trading Spreads and Liquidity: Being new, all three Canadian-traded ETFs are tiny in terms of net assets, which adds cost through higher bid-ask spreads (i.e. you buy at a higher price and sell at a lower price). For those wishing to trade thousands of shares that will be a bigger problem as the market making ETF sponsor may be obliged to step into the market at a bigger spread.
Which ETF is Best?
The choice is really between Claymore's CHI and BMO's ZCH. For those too worried about currency effects, ZCH hedges the currency exposure and it also has the lowest MER by a fraction over CHI. For investors with a long term investment intention who feel currency effects will wash out, CHI offers the best diversification, a reasonable management fee and convenient account features.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.


financebanter said...

Great article...these type of articles make me observe a reversal forming on ECH to begin shorting heavily...

currency comparison said...

It's a nice informative blog for online currency comparison services. It is helpful for money transfer and currency exchange.

JohnK said...

Well, it looks like BlackRock has decided to terminate its CHI fund as of Aug. 27, 2015; https://www.blackrock.com/ca/individual/en-ca/products/239480/ishares-china-allcap-index-fund

I wonder why?