Smaller And Better

Published on Wednesday, 16 May 2012 23:04 Written by Todd Shriber

As many investors now know, China is the world’s second-largest economy and a dominant force on the global economic stage. The exchange-traded products industry is representative of China’s girth and economic importance. There are now approximately 230 ETFs on the market offering exposure to the world’s biggest country by population.

But even with that large number, a disproportionate share of the assets and average daily volume flowing into China ETFs keeps finding its way to the iShares FTSE China 25 Index Fund (NYSE: FXI). FXI, which debuted in 2004, is now home to $5.5 billion in assets under management, making it one of the largest country-specific funds on the market today.

As is often the case with ETFs, bigger isn’t always better. In fact, bigger is rarely better and the SPDR S&P China ETF (NYSE: GXC) proves as much. GXC, one of FXI’s most direct rivals, came along in 2007 and is no shrinking violet when it comes to assets under management with almost $880 million. Home to 180 stocks, it can easily be asserted that GXC is more representative of China’s dynamic economy than FXI, which holds just 26 stocks.

Not only has FXI been criticized for its small number of holdings, the fund has been dinged for an almost 54% allocation to the financial services sector. That makes the ETF particularly vulnerable when fears about Chinese inflation are high. Yes, financials are GXC’s largest sector weight as well, but that allocation falls to just over 31%, but the SPDR offering also features double-digit weights to four other industry groups – energy, technology, telecom and industrials.

On another note, valuation must be addressed. It should be acknowledged that everyone and his sister have said Chinese stocks are cheap recently, but they keep falling, looking cheaper along the way. It should also be said that different ETF providers calculate P/E ratio for their funds in different ways.

Working on the premise that different methodologies don’t lead to vastly different results, FXI’s current P/E ratio is almost 13. That’s fairly cheap in the emerging markets universe, but GXC sports an even less expensive P/E at 9.3%.

Maybe the aforementioned factors aren’t enough to convince some investors that if they’re going to play Chinese large-caps via ETFs that GXC is the preferred option over FXI. Maybe this will: GXC charges just 0.59% per year, meaning for every $10,000 you invest in the fund, you lose $59 in fees. FXI charges 0.72%, meaning for every $10,000 you invest in that ETF, you lose $72. After a while, the lower fees make a difference.

And if that doesn’t do the trick, performance should. Year-to-date, in the past 12 months and in the past five years, GXC has beaten FXI in terms of performance, the most important metric of all.