China ETFs are down but not out.
China's benchmark Shanghai Composite Index has fallen a staggering 57% so far this year and is heading toward its first down year since 2005. Other major global indices haven't been hit nearly as hard. The
and the FTSE 100 have posted declines of 15% and 19%, respectively. And the downward spiral in China may not be over yet.
Investors last Tuesday traded 18.6 million shares of the
iShares FTSE/Xinhua China 25 Index
, the largest China-focused exchange-traded fund. The fund's average volume over the past three months has been 20.3 million shares traded daily.
It is only a matter of time before the Chinese markets recover, but the journey is likely to be volatile. "In the short term, I am not very optimistic," said Charles Zhang, managing partner for
. The Shanghai Composite dipped below 2,300 on Tuesday for the first time this year, which Zhang had expected. On Friday, it closed just above 2,200. Over the long term, Zhang thinks China holds a lot of promise.
FXI, which has $6.3 billion in total assets, has staged one of the biggest runs by any ETF. In the two years through December 2007, the fund surged more than 200%. FXI has top holdings that include
China Life Insurance
. The fund has a price-to-earnings ratio of 14.3 and a yield of 2.8%. These metrics stack up well against the
iShares S&P 500 Index
, which has a 13.3 P/E ratio and a 2.2% yield.
Zhang acknowledges that China has faced some of the headwinds that have recently proved to be a drag on U.S. markets. "Right now, even their growth rates are starting to slow down a bit," he said. "Inflation is also starting to creep up slightly in China."
Within FXI, Zhang especially likes China Life Insurance. "It's the largest life insurance company in China," he said. "It has huge potential with China's population."
Another holding that Zhang likes for the long haul is China Mobile. "It's in a very profitable business because people live on the phone in China," he said.
Almost all of FXI is weighted in large-cap stocks. And while it is the largest China-focused ETF, it is not the only game in town. This past winter, the
Claymore/AlphaShares China Small Cap Index ETF
Claymore/AlphaShares China Real Estate ETF
were launched in order to give investors an opportunity to buy ETFs that have more small-cap and real-estate exposure in China.
These two ETFs have top holdings that include
China Medical Technologies
( CMED) and
E-House China Holdings
. "Our long-term outlook for China is quite favorable," said Kevin Carter, CEO of
."It most likely will be the world's largest economy in the future."
One of the benefits of the China Small Cap Index ETF is its asset allocation. Approximately a quarter of the fund is allocated to consumer goods and consumer services. FXI, on the other hand, has no exposure to either of these sectors. "The real story in China is the growth of the Chinese consumer," Carter said. "China has a very industrious population."
Despite the torrid pace of growth of international equities in recent years, Carter continues to see even more upside potential in the years ahead. "Most investors don't have enough exposure to China," he said. "We think that it is the place to be for the next 10 to 20 years."