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China ETFs: Small-Caps can Keep Shining


Save for those funds with heavy exposure to Internet names, 2013 has not been a great year for China ETFs. To be fair, it has not been a great year for the large-cap funds as the iShares China Large-Cap ETF (FXI) is off 3.5%.

Treatment of China ETFs has recently improved as FXI has surged 18% over the past three months, but investors may want to consider embracing a China ETF that offers exposure to the familiar themes of increased domestic consumption and a growing number of newly affluent and/or a rising middle class. With a significant chunk of its portfolio allocated to state-run mega-cap banks and energy firms, FXI is not intimately correlated to China’s domestic consumption trends and its growing middle class. [ETFs to Play China's Domestic Consumption]

The Guggenheim China Small-Cap ETF (HAO) is. “HAO has about 27% of its portfolio in consumer stocks (which includes auto manufacturers, retailers, and food and beverage companies),” notes Morningstar ETF Analyst Patricia Oey. HAO’s “19% weighting in industrial firms includes airlines and airport companies, which are expected to benefit from growth trends in travel and tourism. And while HAO does hold government-controlled entities, many of its holdings are privately owned, more entrepreneurial companies.”

HAO’s sector diversity relative to FXI (the former’s weight to financial services is just 14.8% compared to 55.5% for FXI) can make a difference when it comes to returns, particularly over longer time horizons. In the past year, HAO is up nearly 30% compared to 12% for FXI. Over the past two years, HAO has returned 55.5% compared to 35% for FXI. Including this year, HAO has outpaced FXI in four of the past six years. [Bright Spots Among Emerging Markets ETFs]

That does not mean HAO is a perfect ETF. As with any emerging markets ETF, there are risks to consider. “five-year annualized standard deviation of monthly returns (a measure of volatility) was 32.7%, higher than the MSCI China Index’s 27.0% and the MSCI Emerging Markets Index’s 27.5%,” said Oey.

Additionally, China retail sales are mixed at best this year. “July retail sales rose 13.2% year-on-year, down from 14.3% in 2012 and 17.1% in 2011, indicating slowing consumer activity,” according to Morningstar.

However, HAO’s two-year volatility is 24.7%, slightly below the 25.3% posted by FXI. Plus, HAO’s weight to the technology sector is over 12%, giving the ETF some leverage to soaring Chinese Internet stocks. Yoku Tudou (YOKU) and Sohu.com (SOHU) are the ETF’s two largest holdings, though HAO does not allocate more than 2.24% to any of its 251 holdings. [China Internet ETF may not Need Alibaba]

Guggenheim China Small-Cap ETF

ETF Trends editorial team contributed to this post.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.