Comparing the Broad China ETFs, Part 2

Here's something I wrote more than a year and a half ago.

The Chinese economy has grown more than 50% in the last 5 years. Good companies grow profits at a rate faster than GDP growth. Companies with rising profits generally have rising shares. So why does the Shanghai composite 5-year chart look like this:

I then referred to this article by John Christy.

One of the main reasons to invest abroad is to find growth opportunities that don't exist at home. Another reason is to invest in companies that are better-run than the ones you'd normally choose from. FXI hardly helps you accomplish any of this.

I pasted that chart on March 14, 2006, when FXI sold for $71.80. It closed at $208.09 on Friday, a gain of 190% in less than 20 months.

There are some good companies in iShares FTSE/Xinhua China 25 (FXI), but I'd prefer to own something other than state monopolies. That said, FXI invests in H-shares, which will should soon eventually be available for purchase by mainland investors. They are currently paying a steep premium for A-shares, the only available shares besides the illiquid B-share market. As a trade it probably has room to grow, but I would not buy this as an investment.

PowerShares Golden Dragon Halter USX China Portfolio (PGJ) has two features that make it stand out as a potential investment. The first is that it invests in ADRs. In theory, this should provide investors with increased protection, but that isn't necessarily the case. The best example of what can happen with a Chinese ADR is China Yuchai. You'll find several articles by Peter A. Delgado, II, an investor in China Yuchai (CYD) at Seeking Alpha. Anyone interested in investing in China should take the time to read all his posts.

The second feature of PGJ is it's heavy technology exposure. Many Chinese tech companies listed in the United States, where capital was easier to acquire, and the result is a large number of companies to choose from. That said, the Alibaba IPO (1688.HK), may change things. If Chinese companies increasingly look to Hong Kong for financing, investors in a strictly ADR fund could miss out on some opportunities. Nonetheless, this is a tech heavy fund, because there are several technology names hiding in the consumer discretionary and industrial sectors. By my estimate, the fund has roughly 23% in tech, 8% more than the 15% listed on the PowerShares website.

Finally, there is the S&P/Citigroup BMI China Index (GXC). The strength of this fund lies in its diversification across markets. It holds ADRs as well as H-shares, offering exposure to technology while also offering many consumer names that are unavailable as ADRs. Like the other two funds, this one also allocates a large portion of assets to mega-cap state owned firms, but if I had to pick one fund of the three to best represent the available universe of Chinese equities, this would be it. Whether it will be the best performing investment is a separate question.

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.