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China ETFs Soar; Small Caps Key To Investing Success?

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I nternational exchange traded funds diversify investor portfolios. Foreign small caps do so even more. So say ETF strategists at CLS Investments in a new white paper titled "Why International: The Case For International Investing."

"Many large international companies are global giants ... with broad market conditions heavily impacting their earnings," the authors wrote. "On the other hand, many smaller companies are more dependent on the conditions within their local economies."

That makes foreign small caps effective diversifiers for successful investing , says Konstantin Etus, an associate portfolio manager at CLS, which manages more than $7 billion in assets.

International small caps may, in some markets, offer better diversification without more risk relative to their large-cap peers, said Etus, who co-authored the paper.

That's true in China, he adds. ETFs tracking the nation's equities have rocketed year to date.

CLS invests inGuggenheim China Small Cap ( HAO ). The $265.7 million ETF soared 31.9% in the past month and 28.1% in 2015 so far.

HAO holds 305 stocks. The average market cap is $2.13 billion.

In the same periods, iSharesChina Large Cap ( FXI ), with $6.71 billion in assets, rose 21.4% and 21.2%.

Investors have rushed into China funds as the nation embarks on reforms. Stimulus measures are under way. A new trading link, the Shanghai-Hong Kong Stock Connect, is opening up the economy.

Chinese firms are benefiting.Baidu ( BIDU ),YY ( YY ),Sina ( SINA ),Qihoo 360 Technology (QIHU) andTencent Holdings (TCEHY) scored big stock market gains last week.

New China, New ETFs

The two best-performing nonleveraged ETFs year to date have a China small-cap skew. Both launched in 2014.

Van Eck Global's ChinaAMC SME-ChiNext (CNXT) has soared 58.2%. Deutsche X-trackers Harvest CSI 500China A-Shares Small Cap (ASHS) is up 43.6%.

They offer U.S. investors direct access to prized China A-shares. Based in mainland China, these companies are listed on the Shanghai and Shenzhen exchanges.

A-share stocks surged in popularity late last year after restrictions on foreign investors were eased.

CNXT holds 100 small and midsize companies, the kind driving much of the innovation and growth in China. It assigns more than half its $68.6 million in assets to "new economy" technology and consumer stocks.

"These are the sectors (that are) going to lead" as China transforms from an investment-driven to a consumption-driven economy, said Amrita Nandakumar, an ETF product manager at Van Eck Global.

ASHS is more diversified than CNXT, with 502 holdings. It has $65.8 million in assets and allocates more heavily to industrials and materials.

Investors have turned to smaller China companies of late because "there's more benefit to be had," Etus said. CLS favors HAO for its longer track record. It's also larger and more liquid than its new peers.

"It's the most stable, reliable ETF for China small-cap exposure," Etus added.

HAO invests in H-shares and N-shares, Chinese stocks listed in Hong Kong and the U.S, respectively. Holdings are entrepreneurial and nonstate owned. After the A-shares gold rush, H-share valuations are seen as more compelling.

Despite the big run-up in China ETFs, the country's equities have room to run, according to investment research firm S&P Capital IQ.

"Solid real GDP growth should help fortify investor bullishness for Chinese shares," S&P Capital IQ analysts wrote on March 6.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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