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.

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)
SPDR S&P China ETF (GXC)

Here's a brief description of each fund from each sponsor's website:

FXI:
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.

PGJ:
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.

GXC:
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

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

GXC
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

PGJ
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

FXI
Giant 90.73
Large 9.27

GXC
Giant 65.63
Large 22.81
Medium 10.43
Small 1.03
Micro 0.10

PGJ
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


FXI
10.62% CHINA MOBILE LTD
9.47% PETROCHINA CO LTD-H
8.84% CHINA LIFE INSURANCE CO-H
5.84% IND & COMM BK OF CHINA - H
5.04% PING AN INSURANCE GROUP CO-H
4.98% CHINA CONSTRUCTION BANK-H
4.90% CHINA SHENHUA ENERGY CO - H
4.19% CNOOC LTD
3.98% CHINA MERCHANTS BANK - H
3.92% CHINA COMMUNICATIONS CONST-H
Total: 61.78%

GXC
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%

PGJ
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.

Expenses

FXI 0.74%
GXC 0.59%
PGJ 0.70%

Source: Morningstar.com

Performance