Why Hot China Stocks Are On The Radar Of Fund Managers And Investors

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Stocks of Chinese giants like Alibaba ( BABA ), Baidu ( BIDU ) and ( JD ) surged before their inclusion in MSCI's international indexes late last year.

Now, the chance for a repeat is here with the second phase of MSCI's addition of U.S.-listed Chinese companies (N-shares), says Michael Krause, president of AltaVista Research in New York City.

The first phase, on Nov. 30, "produced quick, tidy profits for those who purchased ahead of time," AltaVista noted in a May newsletter. The second stage takes place on May 31 after the market close.

This has important implications for investors.

Several index mutual funds and ETFs track the affected MSCI indexes. One example is iShares MSCI Emerging Markets ( EEM ).

Passive managers will have to buy the inclusion stocks at the close of May. Actively managed funds benchmarked to MSCI indexes are likely to do so ahead of May 31. Active managers can buy and sell stocks as they please, after all.

Expect possible spikes in trading volume and share prices for Alibaba and its peers leading up to the MSCI inclusion. That is what happened during phase one, according to AltaVista.

Diversified ETFs are an ideal way to benefit from any "index inclusion bump" for these stocks, the firm's analysts write.

The three exchange traded funds with the biggest stake in this group include KraneShares CSI China Internet ( KWEB ), PowerShares Golden Dragon China (PGJ) and KraneShares CSI New China (KFYP). Each has nearly half its assets, or more, in the inclusion stocks.

Last October, prior to the first stage of inclusion of N-shares, KWEB went up 7%. At the same time, the S&P 500 added 1.3% while the broad MSCI China index lost 2%, according to KraneShares.

Investors could, of course, just buy the stocks.

However, round-trip commissions for more than a dozen separate stocks "could easily overwhelm any gains unless the positions were quite large," AltaVista analysts noted.

To reduce risk in a notoriously volatile asset class, they suggested pairing an ETF such as KWEB with a short sale in a fund such as iShares MSCI China (MCHI).

Altogether, 14 Chinese U.S.-listed stocks were added to MSCI's emerging market indexes in the first phase. Their portfolio weights are poised to double in the second phase.

Many are e-commerce and tech names that frequently pop up on IBD's winning growth-stock lists: (CTRP), Qihoo 360 (QIHU), Vipshop Holdings (VIPS), NetEase (NTES) and TAL Education Group (XRS) .

There's also New Oriental Education (EDU) , a current IBD 50 stock.

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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