Comparing the broad China ETFs, Part 1

There are three major China ETFs. In this post I want to examine what each fund offers investors looking for a slice of the economy that surpassed the United States as the engine of global growth.

iShares FTSE/Xinhua China 25 Index Fund (FXI)
PowerShares Golden Dragon Halter USX China Index (PGJ)

Here's a brief description of each fund from each sponsor's website:
The iShares FTSE/Xinhua China 25 Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the FTSE/Xinhua China 25 Index.

The PowerShares Golden Dragon Halter USX China Portfolio (Fund) seeks to replicate, before fees and expenses, the Halter USX China Index, which is comprised of the U.S. listed securities of companies that derive a majority of their revenue from the People's Republic of China.

The S&P®/Citigroup® BMI China Index is a float-adjusted market capitalization weighted index that defines and measures the investable universe of those publicly traded companies domiciled in China that are legally available to foreign investors.

Right off the bat, PGJ distinguishes itself by assembling the fund using only U.S. listed securities versus GXC and FXI, which are invested in Hong Kong listed shares. GXC and FXI are similar, but FXI has a 10% cap on individual stocks and is limited to the top 25 Chinese firms—even though it currently holds 29 securities. PGJ holds 75 securities as of Thursday's close; GXC holds 201.

Sector Weights

39.7% Financials
17.9% Telecommunications
17.5% Oil & Gas
13.1% Basic Materials
9.2% Industrials
2.4% Utilities

28.8% Financials
21.3% Energy
16.4% Telecommunications
12.1% Industrials
7.5% Materials
4.6% Consumer Discretionary
4.0% Information Technology
2.8% Consumer Staples
2.4% Utilities
0.2% Healthcare

21.1% Energy
20.8% Telecommunications
14.0% Information Technology
14.0% Industrials
8.2% Materials
8.1% Consumer Discretionary
5.1% Financials
4.5% Utilities
3.5% Healthcare
0.5% Consumer Staples

FXI is strictly the top companies by market cap, which turn out to be state-owned enterprises with monopoly-like status. The banking sector is dominated by the large state owned banks, and while it may be a surprise, it isn't shocking to learn that nearly 40% of the fund is financials, double the weighting of the S&P 500 Index. GXC owns a broader cross section of companies, but financials still dominate the fund. Due to limited financial ADRs, PGJ holds only 5% in this sector.

Energy and telecommunications are even more narrowly dominated by SOEs and because ADRs are available, these two sectors have the largest weights in PGJ.The third sector in PGJ, however, is information technology. Due to difficulties in listing domestically, plus American experience in bringing technology companies public, many Internet firms have chosen to list in the U.S. Since the Halter USX Index includes all stocks with market capitalization greater than $50 million and is limited to U.S. listed shares, technology is weighted heavily. GXC holds some American listed information technology as well.

Beyond the top three, excepting materials, the three funds diverge in their holdings. FXI sticks to the industrial giants, while GXC achieves a broad representation of the Chinese economy. PGJ is more heavily weighted towards consumer discretionary and healthcare.

Market Cap Weighting

Giant 90.73
Large 9.27

Giant 65.63
Large 22.81
Medium 10.43
Small 1.03
Micro 0.10

Giant 40.28
Large 12.57
Medium 33.74
Small 8.45
Micro 4.95

Source: Morningstar.com

FXI is 100% large cap or greater, GXC is 88%, PGJ is 52%.

Top Ten Holdings

Total: 61.78%

China Mobile Ltd 13.36%
Petrochina Co 7.34%
China Life Insuran 6.96%
Cnooc Ltd 4.52%
China Const Bk 4.34%
China Petroleum 3.83%
Ind & Com Bk China 3.69%
China Shenhua Ener 3.22%
Ping An Insurance 2.60%
China Cosco Hldgs 1.95%
Total: 51.81%

PetroChina Co. Ltd. (ADS) 7.14%
China Mobile Ltd. (ADS) 6.09%
China Petroleum (ADS) 5.28%
China Telecom Corp. Ltd. (ADS) 5.24%
China Life Insurance Co. Ltd. (ADS) 5.10%
China Netcom Group (ADS) 5.08%
Aluminum Corp. of China (ADS) 4.70%
CNOOC Ltd. (ADS) 4.63%
Huaneng Power Inc. (ADS) 4.49%
China Unicom Ltd. (ADS) 4.35%
Total: 52.1%

The top ten holdings in each fund are very similar, with individual weightings as the main difference.


FXI 0.74%
GXC 0.59%
PGJ 0.70%

Source: Morningstar.com


Chinese Economic History

Joining some pioneer studies on Chinese firms, this research compares China's experience with that of the West, and then rejects a unique Chinese pattern. As it shows in the story, Chinese entrepreneurs possessed the same entrepreneurs' instinct as their Western counterparts, and they would respond to similar problems related to new social, political, economic, and technological situations with some similar innovations in managerial arrangements. However, unlike some early studies, my dissertation suggests a linear path of institutional development of this particular enterprise. It is a path from small to big, from personal to contractual, and from traditional to modern.19 Eventually a "jituan" or Chinese business group appeared in 1940s with a multidivisional structure under the control of a central office. As my narrative will show, the creation of a "jituan" was a response to a series of business crises the enterprise faced in 1930s and 1940s. Many of institutional innovations started as an expedient arrangement targeting one temporary problem, and were maintained after the particular crisis was relieved. Ironically, this new business institution was hardly influenced by the newly-enforced Chinese company law or the efforts of early-twentieth-century reformers, two topics that have been well studied to understand China's modern business development.20 In fact, according to the company law, "jituan" was not even a legally recognized form of business organization. Again, entrepreneurship is emphasized as the main driving force for the institutional development of this industrial enterprise.

One point illustrates why history is critical:
After Deng Xiaoping's Southern tour of 1992, China started to promote a socialist market economy, in which the state-owned enterprises were gradually transformed into a revised version of Modern Corporation. To offer the theoretical guide for this new transition, Chinese scholars turned to look at the business practice both in the West and in the past. A considerable amount of studies on company history was produced during this period. One of the major agenda of these researches was to justify the reform policy by discovering the similar "capitalist" practices in indigenous Chinese businesses---so the new reform would appear ideologically more "Chinese" and less "capitalistic." In late 1990s, when the economic reform was deepened and the privatization movement has already started, economic historians in China had little ideological confusion left. Influenced by Chinese economists, who borrowed institutional economics from the West, they continued to study the history of Chinese enterprises but with a new interest in their institutional development.


Commodities Growth

Although the main focus of this blog is to analyze equities, commodities offer an uncorrelated way to play Chinese growth. Here's the September press release from the Dalian Commodities Exchange:

According to the latest statistics from China Futures Association, the performance of the national futures market in general was appeared brisk. For China's futures market as a whole, in September, the total volume and turnover increased 149.6% and 113.29% respectively from a year ago to 85.4 million contracts, worth 3.8 trillion yuan, and was 33.46% and 8.14% upper than August respectively. The total trading volume and the turnover from January to September were 455.7 million contracts and 26.1 trillion yuan, up 46.16% and69.71% respectively from last year.
Dalian Commodity Exchange (DCE) achieved a trading volume of 51.03 million contracts and a turnover worth 1.69 trillion yuan, accounting for 59.74% and 44.12% in all of China's three commodity futures exchanges. The trading volume increased by 486.26% from a year ago and 84.06% than August respectively, while the turnover was 866.75% higher compared to September 2006 and increased by 99.75% from August respectively.

Investment Terms

All subsequent posts will be located under the Dictionary tag.

Invest: 投资 tóuzī
Stock: 股票 gǔpiào
Common Stock: 普通股 pǔtōng gǔ
Stock Market: 股市 gǔshì
Price to Earnings Ratio:市盈率 shì yíng lǜ
Profit: 利润 lìrùn
Profit Margin: 边际利润 biānjì lìrùn
Debt: 债务 zhàiwù
Equity: 所有者权益 suǒyǒuzhē quányì
Security: 证券 zhèngquàn
Derivative: 衍生证券 yǎnshēng zhèngquàn

Chinese Stocks: The American Option

If you want to invest directly in China without purchasing shares in Mainland companies, there are many stocks available on the American exchanges. These companies must comply with American listing standards, although as Jonathan Weil points out, that isn't necessarily saying much.

The are several major differences between the available stocks. First, some are ADRs of Chinese state-owned companies. China Mobile (CHL) falls in this category. Some of these companies have very odd share structures, such as China Yuchai (CYD). Shareholder Peter Delgado, II, is an activist shareholder in CYD, and he's written several articles on the company. Anyone who's serious about investing in state-owned companies should read his articles, which can be found on Seeking Alpha.

Next are Chinese companies that have listed directly on a U.S. exchange. Since it is difficult to list on the mainland exchanges, many companies chose to list overseas—especially Chinese internet companies. Here's a small part of Shanda's investor relations FAQ:
20. Where and when was Shanda incorporated?
Shanda was incorporated in the Cayman Islands in November 2003, however, our business was founded in December 1999 under the Shanghai Shanda Networking Co., Ltd.

21. Where is Shanda's stock listed?
Shanda's stock is listed on the NASDAQ National Market under the ticker symbol SNDA.

22. When did Shanda go public, and at what price?
Shanda issued 13,854,487 ADSs (American Depository Shares) on May 13, 2004 at U.S. $11 per ADS in its initial public offering (IPO). On June 2, 2004, Shanda held the closing for the over-allotment option in connection with its IPO. At this closing an additional 1,505,634 ADSs were purchased from Shanda and the selling shareholders, which increased the total outstanding Shanda ADSs to 15,360,121 and the total outstanding Shanda ordinary shares to 141,818,280.

Finally, there are American companies who do the vast majority of their business in China. A good example of this is Chindex (CHDX).

You can find American listed Chinese companies with market caps over $50 million at the website for the Halter USX China Index.

Wu Xiaoling: RMB Will Not Appreciate Quickly

Wu Xiaoling, the deputy governor of the People's Bank of China said, "If we rush things too much, this will hurt the Chinese economy and the global economy," she said. "We are moving in a smooth manner, and this will help us all."

Here's the anti-China slant from the Washington Times.

The currency issue remains an important factor in investing in China and can greatly affect returns. However it is not a reason to invest in equities, only a factor used when deciding which equities will outperform given the current situation.