T he violent sell-off in China stocks has put many ETF investors on edge. They bought these shares during their massive run-up in the past year. Now their prized investments are fast dwindling in value.
Warnings about a Chinese stock bubble and frothy valuations are becoming common. But there's an elephant in the room when it comes to investing in the region, say ETF experts.
That's the extremely large presence of state-owned enterprises (SOEs) in popular Chinese benchmarks.
"It's one of the big risk factors out there," says Jeremy Schwartz, WisdomTree's director of research. "Governments may not always be the best stewards of capital and government-owned companies might be influenced by a broader set of interests, beyond generating profits for shareholders."
Yet SOEs account for more than 70% of popular Chinese benchmarks, according to WisdomTree. The communist nation has one of the world's largest concentrations of government-owned businesses.
So the fifth-largest ETF sponsor recently revamped a product focused solely on Chinese equities. WisdomTree China Dividend ex-Financials ETF is now WisdomTree China ex-State-Owned Enterprises ( CXSE ).
It's more than a name-and-ticker change. A new indexing method specifically screens out SOEs while giving access to China's private sector and growth potential.
"Long term, China is one of the better growth stories out there," Schwartz said in a phone call. "People want access to that economic potential."
With CXSE, they get to own consumer-driven, "new economy" sectors. The ETF allocates roughly 30% to technology and has big stakes in consumer stocks.
That's far removed from traditional China ETF portfolios jam-packed with large banks and other financial stocks.
Market Vectors ChinaAMC SME-ChiNext ( CNXT ) also focuses on privately owned companies. But unlike that peer, CXSE invests in Hong Kong-listed H Shares and Chinese companies trading in U.S. markets.
The ETF's focus on H shares can be a plus for successful investing. They have less eye-popping valuations than A shares, which trade on the Shanghai and Shenzhen exchanges, Schwartz said.
A shares fell harder in the recent sell-off after a more spectacular run-up in the past year.
Access to highly coveted China A shares is tightly controlled for foreign investors. WisdomTree does not currently own any, but that could change, Schwartz said.
CXSE has a 0.53% expense ratio.
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