Charting Emerging Market Strength In China ETFs

As a group, emerging market countries have had a mixed year that has led to flat performance in 2014. (See article: What Is An Emerging Market Economy? ) The Vanguard Emerging Market ETF (VWO ) is currently sitting near the zero line in total returns after several promising starts and subsequent dips. The real story behind this performance is the tug of war between faltering natural resource-based economies in Russia and Brazil and the economic strength of India and China. (See article: The Risks Of Investing In Emerging Markets .)

China in particular has, as an investment opportunity, been a challenge to investors, who have conflicting views on how to profit from China’s boom. The powerful growth engine of this Asian economy continues to offer promising reward potential that has yet to materialize in the same manner as red-hot U.S. stocks. However, recent indications of escape velocity momentum. in the form of a steep, sustained and speedy move of stock prices upward, may signal that a breakout is taking shape over multiple timeframes.

With the proliferation of innovative ETFs in recent years, there are now numerous ways to play the recent strength in China and a successful outcome may depend on integrating the right fund in your portfolio. From individual sectors to specific share classes, the China stock market offers a wealth of untapped opportunity along with specific categorical risks. (For related reading, see article: Investing in China .)

The most well-known barometer of the China stock market for U.S. investors is the iShares China Large Cap ETF (FXI ). This ETF has over $6 billion in total assets and this year changed its underlying holdings from a narrow 25 quasi-governmental companies to a broader index of 50 large cap stocks. (See article: Understanding Small- And Big-Cap Stocks .)

A look at a one-year chart of FXI shows the start of a new up-trend since it bottomed in March. It is currently trading above both its 50 and 200-day moving averages and until just days ago was sitting near its 2014 highs. More recently, there has been a clear pattern, in which short-term dips do not affect a constant uptrend, which remains intact.

Reviewing a long-term 3-year chart of FXI shows the context of this current breakout versus the 2013 high water mark. The ability to hold above that prior level (horizontal line on chart) or maintain the upward sloping 200-day moving average could be seen as a bullish sign for these stocks. (See: Introduction: Bullish vs. Bearish )

Now if China is indeed beginning the early stages of a breakout, the question becomes: Is FXI the most successful way to play that opportunity given the myriad of ETF alternatives?

Reviewing the landscape may lend itself to having multiple options at your disposal in order to capture a broader swath of the available China marketplace. With FXI having a limited scope of just 50 stocks in its portfolio, other funds may offer the ability to enhance diversification or hone in on a specific area of the market.

The SPDR S&P China ETF (GXC ) offers the ability to invest in a wide spectrum of Chinese companies available to foreign investors. GXC contains over 300 individual stocks across a range of market capitalizations and currently has over $1 billion in total assets. Over a 3-year timeframe, this ETF has outperformed FXI by a margin of 10%, driven by the strength of its diversification.

Investors that want to hone in on just the small cap segment of the Chinese market should consider the Guggenheim China Small Cap ETF (HAO ). This ETF selects 270 companies with a maximum adjusted market capitalization of $1.5 billion. While HAO has underperformed FXI in 2014, this strategy may be considered as an accompaniment to a traditional large-cap ETF as a means of including smaller companies with higher regional growth potential.

Another inventive China opportunity is the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR ). This ETF offers access to 300 of the largest and most liquid China A-share companies. Stocks with an A-share designation have previously only been available to mainland Chinese investors and are now being offered to foreign investors for the first time. ASHR now has over $700 million in total assets and has skyrocketed more than 30% this year as access to this coveted market has expanded. However, it’s worth mentioning that the significant upside may manifest in added volatility on any pullbacks as well.

Lastly, there is always the propensity for individual sectors to shine such as the KraneShares CSI China Internet ETF (KWEB ). This unique index provides exposure to internet and e-commerce companies based in China such as the high profile Alibaba Group Holdings (BABA ). KWEB has been largely flat this year, but has shown the propensity for high beta gains in the past.

Each of these ETFs offers a dynamic approach to China-based investments that can be used as either core or tactical holdings. Establishing new positions on pullbacks and having a stop loss in place to manage downside risk, is an approach worth considering for investors looking to broaden their exposure to an emerging market showing continued relative strength.

Disclosure: At the time this article was published, principals and clients of FMD Capital Management held positions in VWO.

The opinions expressed are those of FMD Capital and are subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of any individual holdings or market sectors. This material does not constitute any specific legal, tax or accounting advice. Please consult with qualified professionals for this type of advice.

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