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Women take pictures of a Santa Claus figure outside a shopping mall in Taiyuan, Shanxi province, earlier this month. The torrid pace of growth has raised Chinese living standards and has created a burgeoning consumer class. (JON WOO/REUTERS)
Women take pictures of a Santa Claus figure outside a shopping mall in Taiyuan, Shanxi province, earlier this month. The torrid pace of growth has raised Chinese living standards and has created a burgeoning consumer class. (JON WOO/REUTERS)

The Shrewd Investor

China offers another path to portfolio diversification Add to ...

I wager that everyone reading this column is aware of China’s explosive economic development over the past few decades. Real per capita GDP increased on average 8 per cent annually from 1978 through 2012. The torrid pace of growth has raised Chinese living standards and has created a burgeoning consumer class.

A softening economic growth rate (still a robust 7.0 per cent plus), plus scandals involving Canadian-listed Chinese companies such as Sino-Forest Corp., have soured many investors on the Land of the Dragon. After observing China and its people firsthand during a recent visit, I am convinced that the Chinese investing story is far from over. If you are planning to diversify your portfolio beyond our borders, Chinese equities are worth considering – if you can stomach the volatility inherent in emerging market equities.

Canadians can invest directly in the shares of certain companies listed on China’s Shanghai, Shenzhen or Hong Kong stock exchanges. Trading commissions can be relatively costly for purchases made on these exchanges. Undertaking adequate due diligence is challenging for retail investors as accounting standards may differ and the information available in English could be limited.

An easier way to invest in individual Chinese stocks is to buy American Depository Receipts (certificates representing ownership of non-U.S. company shares). Hundreds of ADRs for Chinese stocks from a cross-section of industries are listed on American stock exchanges. ADR companies meet U.S. accounting standards and information disclosure requirements, and trade just like stocks.

A small holding of Chinese equities is all that many investors want. As such, the allocated dollars in a portfolio may be sufficient only to buy a few individual stocks. A better investing approach in such situations is a mutual fund or an exchange-traded fund that invests in Chinese stocks. A fund provides instant diversification with one purchase and lowers the impact of a losing stock.

The Globe Investor Fund Filter reports 42 funds in the Greater China Equity fund class.

Screening for open-ended funds which are highly ranked, either a four- or five-star rating, reduces the list to just four funds (I have excluded those available only to advisers).

Among these, my first choice is the passively managed BMO China Equity Index ETF (ZCH-T). The fund was launched in January of 2010 and is designed to track the BNY Mellon China Select ADR Index. This index consists of 50 large capitalization Chinese companies which trade as ADRs on an American stock exchange. The top three sectors, information technology, energy and telecommunications, make up about 70 per cent of the fund. The MER is 0.74 per cent. The portfolio yield is currently 1.62 per cent and distributions are annual. The fund offers an element of currency diversification as hedging to the Canadian dollar ended effective Sept. 28, 2012. One- and three-year returns were 43.29 per cent and 2.50 per cent respectively.

The best of the mutual funds is the long-established Renaissance China Plus Class A Fund. The 3.32-per-cent MER is excessive in my opinion, but performance has been top of class with one-, three- and five-year returns of 38.60 per cent, 0.60 per cent and 17.2 per cent respectively. Accumulated income and capital gains are distributed in December. This is an actively managed fund that invests in companies based in, or conducting most of their business in, China and Taiwan. Like ZCH, about 32 per cent of the holdings are in the information technology sector. Consumer discretionary and financials round out the top three sectors, which total about 70 per cent of the fund.

ETFs trading on U.S. exchanges should always be on the radar screen of Canadians shopping for foreign investments. The choice is greater, the fees are lower and the additional currency diversification is a bonus, especially when the Canadian dollar is tanking. The website ETFdb is a good place to begin a search for U.S.-listed ETFs. Their screener generated a list of 28 ETFs with a Chinese equity mandate. If the field is narrowed to funds with multi-sector exposure and at least a three-year track record, two ETFs stand out.

The PowerShares Golden Dragon China Portfolio ETF (PGJ-NYSE) tracks the NASDAQ Golden Dragon China Index. The Index includes 69 U.S.-listed companies that derive the majority of their revenue from China. Recent performance has been exceptional with a one-year return of 60.53 per cent. The three- and five-year returns of 5.14 per cent and 17.93 per cent are more in line with other China funds. The MER is 0.70 per cent. There is a quarterly distribution, currently 1.1 per cent. Given its heavy weighting (57 per cent) in the information technology sector, this is the least diversified of the four funds mentioned in this article.

The SPDR S&P China ETF (GXC-NYSE) provides better multi-sector exposure to the Chinese equity market and extends beyond the U.S.-listed Chinese company universe. It tracks the market cap-weighted S&P China BMI Index, a diverse group of 240 publicly traded companies domiciled in China and publicly available to foreign investors. The top three sectors, financials, information technology and energy, make up 62 per cent of the fund. The 17.2 per cent one-year return lags similar funds, but the longer term performance (the three- and five-year returns are 3.08 per cent and 16.72 per cent) is in line with other funds. The MER is a reasonable 0.59 per cent. A dividend of about 2 per cent is paid semi-annually.

The 21st century belongs to China. The easiest way for Canadians to invest in this economic powerhouse is to buy a Chinese equity ETF or mutual fund.

(All returns as of Nov. 30, and are quoted in the currency of the country where the fund is listed.)

Ms. Bebee is Canada’s independent voice on personal finance and author of No Hype –The Straight Goods on Investing Your Money, a popular book of investing basics for Canadians from a financial industry outsider viewpoint. Through her writing, speaking and teaching, Gail shows people how to take control of their money and achieve their financial goals. Her column appears monthly on the Financial Road Map site. Her website is www.gailbebee.com

Follow us on Twitter: @GlobeMoney


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