China Back on Track for Growth

Monday, April 5, 2010

Few doubt that China will stop in its relentless drive for growth. But has foreseeable growth for China ETFs been factored in to prices, and will currency devaluation weaken nominal returns?

The World Bank raised China's 2010 growth estimate half a percentage point to 9.5% in March, so it appears to be emerging from recession. China ETFs remain volatile, but they bounced back from a disastrous 2008 and early 2009 and have settled into more stable trading patterns:

The above graph shows the S&P 500 vs. two popular ETFs: the iShares MSCI Hong Kong ETF (NYSEArca:EWH) and SPDR China ETF (NYSEArca:GXC), with moderate annual fees of 0.54% and 0.6% respectively. Another broad-based ETF is iShares FTSE/Xinhua China 25 ETF (NYSEArca:FXI), with annual fees of 0.74%, and iShares FTSE China (HK Listed) ETF (NasdaqGM:FCHI), annual fees of 0.74%.

Historically Chinese volatility has not concerned US investors with diversified portfolios because Chinese stocks have correlated poorly with US ones. Volatility washed out much of the time. Unfortunately, rising correlations have weakened this effect, so that a bad Chinese year often comes on top of a bad US one. This can be seen from the above graph where SPY, an S&P 500 index fund, has drifted in the same direction as Chinese ETFs.

China ETFs mostly own stocks on Hong Kong and New York exchanges, not Mainland China exchanges. Typically these firms operate on the Mainland. Obviously the firms benefit from attracting foreign capital, and it also benefits investors. Noted economist Burton Malkiel judges these firms on average to be better managed and more transparent than companies listed in domestic exchanges where Government control, weak accounting standards, and wild swings in investor sentiment are pervasive.

For ETFs requiring instant liquidity, meanwhile, restrictions against foreign capital have made it impractical for ETFs to use Shanghai or Shenzhen exchanges. EWH is a bit of an exception; it contains more pure Hong Kong exposure where real estate and banking predominate.

Many economists think China's currency is undervalued by at least 25% and expect steady devaluation. Trading partners and neighbors have increasingly called on China for such devaluation. It seems prudent for dollar-based investors to lower expected nominal returns. A sharp Latin-American style devaluation seems unlikely given the government's export-driven growth policy (requiring a cheap currency) and its strong capital reserve position.

For a more direct currency play there are two ETFs:

  • Van Eck Market Vectors Chinese Renminbi/USD ETN (NYSEArca:CNY), annual fees: 0.55%
  • WisdomTree Dreyfus Chinese Yuan ETF (NYSEArca:CYB), annual fees: 0.45%

Other more specialized plays on China include:

  • Claymore/AlphaShares China Small Cap ETF (AMEX:HAO), annual fees: 0.7%
  • PowerShares Golden Dragon Halter USX China Portfolio ETF (AMEX:PGJ), annual fees: 0.7%

The following dual country ETF might be of interest to investors who want to play India and China in one trade: First Trust ISE Chindia ETF (NYSEArca:FNI), annual fees of 0.7%.

There is a real estate play for China in Claymore/AlphaShares China Real Estate ETF (NYSEArca:TAO), with annual fees of 0.65% .

A leveraged ETF serving the country is ProShares UltraShort FTSE/Xinhua China 25 ETF (AMEX:FXP), with annual fees of 0.95%.

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.