Chinese shares are back in play again after years of being
dogged and shunned like the ugly stepchild.
So, it's time to take a dive into what type of
or even share classes look promising. Regarding favorable sectors,
the consumer space looks particularly attractive.
Increasing domestic demand and a lessening of the country's
dependence on exports has been a main focal point of the Chinese
government's newest Five-Year Plan (2011-2015), and Chinese
officials recently reiterated this point.
Of the various share classes, A-shares focused on mainland
Chinese companies have suddenly turned hot again, after the
Shanghai Composite Index hit a nearly four-year low just a month
ago. Until recently, A-shares were lagging behind the performance
of other Chinese share classes, which have been rallying since late
summer of 2012.
Targeting Chinese Consumers
The most popular China ETFs offer little to no exposure to the
consumer space. The $9 billion iShares FTSE China 25 Index Fund
(NYSEArca:FXI) has zero exposure to the consumer sectors, while the
$1.1 billion SPDR S&P China ETF (NYSEArca:GXC) has only 11
Instead, state-owned mega caps mostly dominate these types of
funds. For example, China Mobile, the four big state-owned banks
and the three big state-owned energy names make up 52 percent of
FXI. Even in GXC-which I consider to be the SPY of China ETFs and
currently the best choice for all-around exposure to China-these
eight companies constitute 36 percent of the fund.
While there's nothing inherently wrong with being overweight
mega caps, investors preferring more exposure to the growth
potential of smaller consumer-focused, nonstate-owned companies do
have a number of other ETFs to choose from.
My two favorites here are the Global X China Consumer ETF
(NYSEArca:CHIQ) and the Guggenheim China Small Cap ETF
As the name suggests, CHIQ specifically targets the consumer
space and holds an assortment of 40 investable Chinese shares from
both the consumer cyclical and noncyclical sectors. The fund holds
mostly H-shares traded in Hong Kong, but also includes a few
U.S.-listed N-shares in the mix.
HAO doesn't necessarily target the consumer space, but it holds
over 200 mid- and small-caps from all investable shares and its
consumer cyclical and noncyclical exposure is roughly 25 percent of
the fund. The fund has about 40 percent in companies with market
caps greater than $2.7 billion, which we consider midcaps.
The iShares MSCI China Small Cap Index Fund (NYSEArca:ECNS) is a
small-cap fund that holds over 300 companies and has about 28
percent exposure to the two consumer sectors. ECNS is more of a
pure-play on small-caps, with 97 percent in companies with less
than $600 million in market cap.
Between the two small-cap ETFs, I prefer HAO. I like that it's
able to hold some larger established names like Tsingtao Brewery
and the Warren Buffett-backed car maker, BYD. Also, it includes
U.S.-listed N-shares in the mix, such as Sohu.com and Youku
Since A-shares are mostly uninvestable to foreigners, current
fund choices are limited. Still, there are a few options, although
they come with some obstacles and additional risks that investors
need to weigh.
In the ETF landscape, there's currently only one option, the
Market Vectors China ETF (NYSEArca:PEK). This fund tracks the CSI
300 Index through swap agreements with Credit Suisse, a qualified
foreign institutional investor (QFII).
However, PEK often trades at a premium to net asset value (
) when demand for A-shares jumps and the cost for swaps increase.
As of Jan. 4, 2013, PEK was trading at a premium north of 11
Van Eck was granted QFII status with a quota for $100 million in
July 2012, so I expect that at some point in 2013, PEK will become
the first U.S.-listed China ETF that holds physical A-shares.
Still, it will be interesting to see how Van Eck will mitigate the
effects on the premium during any transitional period when PEK
switches to holding physical shares.
The actively managed Morgan Stanley China A Share Fund
(NYSEArca:CAF) is also an option, although it's a closed-end fund
and not an ETF. Still, as a momentum play on the China A-share
market, CAF is definitely worth mentioning.
Closed-end funds differ from ETFs because there's no
creation/redemption feature, and thus no arbitrage mechanism in
place to bring the fund back to its NAV-so the fund price is at the
mercy of market forces.
For a good part of the past few years, CAF has traded at
discounts to NAV due to the slowdown in the Chinese economy and a
lack of interest in A-shares. Only recently did CAF rocket to a
premium again, as demand for A-shares jumped.
Just to show how much CAF can move, compared with the Shanghai
Composite's 15 percent returns from Dec. 1, 2012 to Jan. 4, 2013,
CAF has returned 27 percent, juiced by the fund springing back to a
Of course, the flip side can be true as well. If the A-share
market cools off or sells off quickly, then CAF can be hit hard,
especially if the fund swings from a premium back into a
Ironically, CAF's premium is currently less than the
ETF-structured PEK's. As of Jan. 5, CAF's premium was about 5
percent. This just goes to show you the difficulties and
limitations of accessing this "uninvestable" A-share market.
For the time being, PEK and CAF are probably better suited for
momentum plays rather than long-term investments, although PEK
might be interesting once it physically holds A-shares.
From an investment perspective, I still like the consumer space,
such as the ETFs I listed earlier.
An Evolving Market
China will also continue to evolve, and so will China ETFs, so
investors should be open-minded to new funds that launch in the
For example, iShares has an A-share fund in filing that's based
on the FTSE A50 Index. Like PEK, the fund will also use swaps.
On the consumer front, there are a few filings on my radar, like
the Guggenheim China Consumer ETF. Also, KraneShares, a newcomer in
the ETF space, has a pair of consumer-focused ETFs based on CSI
indexes in registration, while Van Eck has an ETF focused on
consumer discretionary and consumer staples in the regulatory
pipeline as well.
At the time this article was written,
the author held long positions in CHIQ and CAF.
Contact Dennis Hudachek at email@example.com.
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