China ETF Bets on Rising Middle-Class

NEW YORK ( TheStreet) -- China has been an important, yet controversial, investment destination for years.

Important because the country is spending money to modernize almost every aspect of people's lives, and controversial as the rest of the world tries to figure out whether there is a lending bubble. Also, China has frosty relations with the U.S. because of the currency peg, trade tariffs, the issue of Taiwan -- even the Dalai Lama.

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I have written about where money must be spent in China. The easiest path to do this is to tap into the country's effort to modernize, which has been under way for years but still has a way to go in terms of delivering a middle-class lifestyle to more people.

There are several exchange traded funds that play into this theme, including the new EG Shares China Infrastructure ETF ( CHXX). There are ETFs that invest in emerging-market infrastructure, not only China, and there are others that focus on specific sectors in China. Only the EG Shares fund combines the two.

The fund allocates money to nine industries within infrastructure, the largest ones being real estate management and development, at 23%; metals and mining, 21%; construction and engineering, 15%; and electrical equipment, 14%.

The inclusion of real estate will surprise some people, but the reasoning is interesting. China wants to bring a middle-class lifestyle to poorer and more rural parts of the country, mostly the western provinces. Part of this lifestyle includes shopping malls and restaurants, which will be built and run by real estate companies. EG Shares' chief investment officer, Richard Kang, made a point of mentioning the importance of lifestyle enhancement as a source of social stability, implying a sort of social contract between the country and its citizens. Safe new roads, malls and cable TV play an important role, Kang said.

This part of the story isolates two important points for would-be investors in the new fund. As mentioned above, there are concerns about whether certain aspects of China are a bubble -- short-seller Jim Chanos has made a lot of headlines in the past couple of months by calling the real estate market in China a bubble.

If stock prices in the Chinese real estate industry drop more than the broader market does, it makes sense to expect that the EG Shares China Infrastructure ETF will have a rough go of things.

The heavy weighting in real estate, and mining for that matter, also addresses a subtler question, at least for this fund. Some have wondered whether infrastructure should be thought of as its own asset class like commodities or bonds. Ideally an asset class would offer some diversification benefit, such as having a low correlation to the stock market during a decline. It seems unlikely that real estate and mining stocks will zig when the stock market zags, making the fund part of an existing asset class, equities in particular, not a new asset class.

That does not mean that the EG Shares China Infrastructure ETF is poorly designed -- far from it. It provides access to what I have been saying is a very important theme in a country that is rapidly moving up in the global pecking order. As I have said, infrastructure is an area where money has to be spent -- and is going to be spent -- which creates a natural tailwind for the theme. This issue with real estate is a risk factor, to be sure, but all ETFs contain risks.

The decision about whether this fund will turn out to be the best proxy for infrastructure in China will boil down to the very simple question of whether real estate will enhance or hinder the fund's performances. Given that China seems to be in the midst of a pullback right now, it makes sense to see how this fund does versus some of its competitors.
At the time of publication, Roger Nusbaum had no positions in the securities mentioned.

Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.