Not All Chinese Stocks Created Equal

Chinese stocks have fared better as other emerging markets plummeted in recent weeks, as has been widely reported. But comparing China to other emerging markets is like apples to oranges. The investor advantage depends on which Chinese stocks one is looking at: The real winners in the China stock story are local Chinese, not foreign investors.

The "Chinese stocks" that most foreign investors own such as Sohu.com (SOHU Quote) and Baidu (BIDU Quote) are owned via exchange-traded funds and mutual funds. These funds, in turn, are comprised of American depositary receipts (ADRs) and Hong-Kong-listed stocks, not local Chinese stocks. This had led to some dislocation -- and perhaps investor confusion -- over the performance of "China" stocks.

During the recent selloff, the two main China ETFs, iShares FTSE/Xinhua China 25 Index (FXI Quote) and PowerShares Golden Dragon Halter USX China Portfolio (PGJ Quote), fell less sharply than other emerging market ETFs. Each is each down about 11% since May 9 vs. declines of 21% for the iShares MSCI Brazil Index (EWZ Quote) and 27.4% for the Morgan Stanley India Investment (IIF Quote) fund.

But, over the same period, China's local stocks have actually climbed against the global downtrend, as Barron's reported. But it is local Chinese investors that have the best opportunity to benefit. The opportunities and rewards are scarce for foreign investors, as regulations insulate its stock markets from the rest of the world.

The story is one of isolation and government control. China's small quotas for foreign investment limit its stock markets' exposure to global liquidity and investment trends, and keep these markets' performance uncorrelated to the recent emerging market bull market, says Steven Sun, analyst at HSBC Bank in Hong Kong.

Stocks included in Hong Kong's Hang Seng Index are more subject to international pressures and economics like interest rate concerns, says Kevin Gardiner, head of global equity strategy at HSBC. The Hang Seng has returned 5.8% year-to-date, but is down 8.5% from its peak on May 8. By contrast, the Shanghai Composite Index has been on a steady uptrend all year, having returned 34.6% year-to-date.