Five ETFs For A China Bank Bubble

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After starting out 2012 with a bang, economic uncertainties are once again creeping in from both sides of the Atlantic and equity markets around the globe appear to be losing steam and heading lower back towards where they started off the year. With Euro zone debt drama back in the spotlight, investors have seemingly brushed aside all other financial news. Perhaps one of the most overlooked developments is the mountain of debt that has been building up in China, leading many to worry that the Asian economic bellwether could soon face a financial crisis of its own [see also Will Gulf State ETFs Thrive From Oil Wealth?].

Infrastructure spending in China over the past few years has done wonders for bolstering investors’ confidence, however, an ugly debt crisis has been brewing in the background as well. A recent article from The Economist takes a closer look at the health of the Chinese banking system, revealing some concerning insights that may have investors scrambling for safety in the foreseeable future. The Asian economic giant appears to be plagued with unhealthy local-government debt and concerning property loans [see also ETFs For China's Investment Sweethearts].

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The Economist cites that the infrastructure spending binge over the past few years has led to a boom in local-government financing vehicle (LGFVs), which is a major concern because these off-balance-sheet entities are used as way of getting around borrowing restrictions. As such, the government has been trying to diffuse the situation by rolling over these loans and pushing them off to “policy banks” like the China Development Bank, who saw close to $80 billion in LGFV debt rolled over from last year alone.

Adding property loans to the mix has further caused reasons for concern. Chinese banks have resorted to shifting debt around from one account to another in an effort to mask the real number of quality property loans which are actually collateralized. Among emerging markets, China has one of the most thinly capitalised banking systems; the ratio of equity to assets is roughly 6%. Charlene Chu of Fitch Ratings cites that if only one-tenth of outstanding credit turns rotten, roughly all profits and close to 40% of the system’s equity will be gone with the wind [see Asia-Centric ETFdb Portfolio].

The potential crunch brewing overseas has led many to believe that dire consequences will follow as a result of China’s recent credit boom. As such, below we highlight five ETFs that may present compelling opportunities for those who are worried of the lurking China bank crisis:

  • iShares FTSE China 25 Index Fund (FXI) : This is by far the biggest, and most actively traded, China ETF available on the market. Investors who value liquidity above all else can certainly utilize this ETF as a trading instrument; furthermore, FXI has half of its total assets allocated to the financial services sector, which means that a short position in this ETF will likely rake in big profits if a bank crisis starts to develop overseas.
  • Global X China Financials ETF (CHIX): What better way to profit from a bubble than to short the troubled sector itself. CHIX pales in comparison to FXI from a liquidity perspective, however, its targeted exposure to the financials sector can go a long way in serving seasoned traders as an excellent trading instrument. This ETF is sure to face strenuous headwinds if China’s banking systems hits a wall, as many are predicting.
Experienced investors with a stomach for risk may wish to play the China bank bubble with leveraged tools, allowing them to magnify gains if their thesis turns out to be correct:
  • ProShares Short FTSE/Xinhua China (YXI): This ETF offers inverse exposure to the same index which the ultra-popular FXI is linked to.
  • ProShares UltraShort FTSE/Xinhua China (FXP): Going up the leverage ladder, this ETF corresponds to twice the inverse daily performance of the FTSE/Xinhua China 25 Index.
  • Direxion Daily China Bear 3x (YANG): This ETF is not for the faint of heart as it offers triple leveraged inverse (-300%) exposure to the BNY China Select ADR Index. As the name suggests, YANG’s exposure is reset on a daily basis.

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Disclosure: No positions at time of writing.

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