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 (NYSEArca: 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 (NYSEArca: 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.