Are China ETFs in Trouble?

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China – the world’s second largest economy – recorded a very slow pace of growth in 2012, far below what the red hot economy had been seeing in many years past. Exports from the country, which play a vital role in the nation’s economic growth trajectory, had been a major worry point as European woes and a slow recovery in the U.S. led to weak demand for Chinese goods.

Additionally, a leadership transition, higher inflation levels and lower global demand for goods impacted the economic health of the once rapidly growing nation of the world (China ETF Investing 101).

Fortunately though, with the global economy regaining strength and U.S. economy showing growth momentum, China may show some improvement in growth albeit at a slower rate. 

Moreover, the Chinese government labored hard to boost domestic demand to set off the declining demand for Chinese goods the world over. The efforts were seen to be working well in recent months as many now believe that China is back on track.

However, recent economic data and weakness in the Chinese stock market tell a completely different story. China’s stock market plummeted to a three-month low last week as various economic data points revealed that the economy may be losing momentum (Do ETFs Suggest that the China Panic is Over?).

China’s inflation rose further in February attributable to the rise in food prices. Additionally, industrial production data disappointed the market with slowing numbers. Industrial production, which was expected to marginally beat the December growth of 10.3%, came in at 9.9% for the January-February period.

Also adding to the grievances of the weak economy was some unconvincing retail sales growth. Retail sales growth moderated to a two-year low of 12.3%. This came in much lower than the expectation of 15.2%.

While any one of these data points may be forgivable in isolation, together they paint a less rosy view of the national economy. This has helped to temper some of the optimism over the area, and push Chinese stocks to lower levels.

In these circumstances, ETFs tracking the region are unsurprisingly on a downward trajectory. The FTSE China 25 Index Fund (FXI), the most popular fund in the family of ETFs providing exposure to the Chinese equity market, has lost 7.44% in the year-to-date period indicating the weakness in the economy since the start of the year (The Right and Wrong Ways to Invest in China ETFs).

In fact, FXI turned out to be a major disappointed last week as the ETF registered a fall of a massive 4.91% in the last week's trading session on weak economic data.

FXI otherwise appears to be one of the most well accepted choices in the family of emerging market ETFs as indicated by its trading volume of more than 17 million shares a day. The fund, which has a large cap tilt, manages an asset base of $7 billion.

Although the fund is one of the most popular choices to tap the Chinese economy the scope of investment is limited to just 26 stocks. Also, the fund is biased towards the top ten holdings, as more than 60% of the asset base goes towards them.

Among individual holdings, China Mobile, China Construction Bank and Industrial and Commercial Bank of China take the top three positions. For investment in the fund, FXI charges a fee of 72 basis points from investors.

For sector holdings, the fund relies too much on the financial sector of the economy (Three Financial ETFs That Avoid Big Bank Stocks). The fund assigns 58.46% to the financial sector with double-digit allocation also made to the telecommunication and oil & gas sectors.

Bottom Line

This is a very important time for China, and for Chinese ETFs. The economy is potentially facing a turning point and some strong data will be need to pull the country out of its current malaise and reaffirm the nation as one of the world’s best growth stories.

Strength in the developed world will certainly be necessary for this, so investors should look to Europe and America for clues. Beyond that, China will definitely need to rebalance its economy further, so a focus on the Chinese consumer could also be key for this nation’s ETFs in 2013.

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