New China ETF Targets Nation's Five-Year Plan

TheStreet.com

NEW YORK (TheStreet) -- Last week we looked at technology as a way to gain exposure to areas of the Chinese economy where money is going to be spent. Such a strategy avoids sectors that may see a slowdown, such as manufacturing.

Right on cue comes the new KraneShares CSI China Five Year Plan ETF .

China has historically operated under five-year economic plans. The most recent one was adopted in 2011. The focus of the current five-year plan, according to KPMG, includes domestic consumption, industrial upgrades and sustainable growth. The KraneShares fund's prospectus also identifies other areas targeted by the five-year plan, including agriculture, transportation and alternative energy.

The new ETF is constructed to capitalize on the priorities specified in the current five-year plan. When Beijing's next five-year plan is implemented, the fund will adjust to any changes in it.

For now, technology is by far the largest sector, accounting for 35% of the fund. Other prominent sectors include consumer discretionary at 16%, industrials at 14% and consumer staples at 14%. The individual holdings come from an investable universe of global companies that derive at least 50% of their revenue from China. This includes ADRs traded in the U.S. and shares traded on foreign markets.

KFYP has 161 holdings. Typically, such a number would make for good diversification, but due to the market-cap weighting of the fund, Tencent Holdings PNK and Baidu each have double-digit weightings, while the third-largest constituent, Want Want Holdings PNK , has a 3.3% weight. Obviously, the remaining holdings have smaller weightings than that. Any sort of meaningful price impairment for Tencent or Baidu likely would be a drag on the fund.

The big idea behind KFYP is essentially what I discussed last week. The segments captured in the fund are where China's government has said money will spent, and that should bode well for the companies in the fund.

As I discussed in last week's article, the tech sector is an avenue to what Chinese people perceive as an Americanized lifestyle, and the demand characteristics for this theme are very favorable.

The heavy weighting in technology, most of which is in Tencent and Baidu, leaves a lot less room for some other market segments including car companies, toll roads and other travel-related companies such as C-Trip , which is up 44% this year but accounts for only 1.35% of KFYP.

The reason to mention these parts of the market is that part of the perceived American lifestyle includes driving a car and traveling, which is now accessible to a larger portion of the Chinese population, and many of the corresponding stocks have done well because of it. The total weighting of stocks in this segment appears to be less than 10%. That means if this sector continues to do well, it wouldn't be enough to offset a decline in Chinese tech.

Another area in the five-year plan that was just re-emphasized this week is railway construction, which is important to help connect various regions of this large country and allow manufacturing to expand into the more rural western part of China. Although the materials and engineering firms involved are mostly represented in the fund, the weighting is not large enough to realistically move the needle of the fund's share price.

China is a very complicated investment destination. There are many different questions about the country that have dominated recent headlines, including whether the nation's economic growth is slowing dramatically, whether its banks will experience a crisis akin to that suffered by the U.S. financial system five years ago and whether pollution in northern China is out of control and will affect the economy.

It has been many years since a broad-based fund such as the iShares China Large Cap ETF has been a productive holding, and given that fund's 52% exposure to the financial sector, it could be a while before broad-based investing in China makes sense again.

As mentioned above, technology and the other components of KFYP have a tailwind of favorable demand characteristics and have a good chance of continuing to outperform.

At the time of publication, Nusbaum had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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