Small-Cap ETFs for China’s Shift to Domestic Consumption

December 19th at 12:00pm by Tom Lydon

Chinese stocks have been relatively weak over much of 2012, but stronger economic data in the fourth quarter has helped lift China’s markets. While investors can pick through a number of country-specific exchange traded funds, small-cap ETFs provide a greater focus on China’s domestic growth story, going into 2013.

“We think Chinese equities may have a place within a diversified portfolio, given China’s standing as the second-largest economy in the world, whose growth will likely outpace that of the developed world in the near and medium term,” according to Morningstar analyst Patricia Oey. [China ETFs March Higher on Manufacturing, Economic Strength]

Most investors tend to focus on the largest China-related ETF, iShares FTSE China 25 Index Fund (NYSEArca: FXI), which tracks the 25 of the largest Chinese companies available to foreign investors. The ETF has a heavy allocation to financials at 59%, followed by telecom services 15.7% and oil & gas 14.7%. The fund is up 15.7% year-to-date.

Beijing wants to shift its strategy away from exports and more on domestic demand, boosting imports and increasing the integration of rural migrants to cities as a way to raise domestic consumption, the Wall Street Journal reports. [ETFs to Access China’s New Growth Phase]

Consequently, investors may consider small-cap Chinese equities as a way to capture the shift inwards.

For instance, Guggenhiem China Small Cap ETF (NYSEArca: HAO) follows the AlphaShares China Small-Cap Index. The ETF’s top holdings include industrials 24.4%, financials 18.7%, consumer discretionary 14.4%, materials 13.1% and consumer staples 9.6%. HAO is up 16.3% year-to-date.

“Relative to broad, cap-weighted funds, HAO provides better exposure to domestic growth trends,” Oey added.

The iShares MSCI China Small Cap Index Fund (NYSEArca: ECNS) tries to reflect the performance of the MSCI China Small-Cap Index, which holds the bottom 14% by market of the Chinese equities market. Top sectors include consumer discretionary 18.9%, industrials 18.6%, financials 15.3%, materials 12.1% and information technology 10.9%. ECNS is up 19.8% year-to-date.

Additionally, the iShares MSCI Hong Kong Small Cap Index (NYSEArca: EWHS) tracks the MSCI Hong Kong Small-Cap Index, which follows the bottom 14% of equity market cap of Hong Kong. Top sector allocations include consumer discretionary 45.2%, financials 18.8%, information technology 13.5%, industrials 9.2% and telecom services 4.2%.

For more information on China, visit our China category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. 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.