It is very difficult for U.S. investors to invest in China because of currency controls, and a lack of an adequate number of Chinese ADRs in the United States. Furthermore, specific company bets are now riskier because of fraud allegations of Chinese companies by Muddy Waters. Muddy Waters has been uncovering fraudulent accounting associated with Chinese reverse takeovers for the last two years.
Currently, the Shanghai Stock Exchange Composite Index trading at a 11.6x multiple, which is far below its range of between 16x and 42x between 2001 and 2010. This reflects not only slowing global growth, but also meaningful discounts to valuations not seen in over a decade.
For a retail investor, a conservative approach to investing in China may be the FXI ETF, an exchange traded fund in the U.S. that represents 25 of the largest Chinese ADRs in the U.S. The Fund invests 90% of its assets in the underlying index, and it’s 25 holdings are included in the table above.
FXI employs a full replication strategy, with a NAV tracking error of 0.189. The ETF is weighted by market cap, doesn’t use leverage, and has an expense ratio of 0.74%, which is lower than mutual funds like Dreyfus’ DPCAX, which charges 1.84%, with a 5% front load. The front load is an egregious sales charge, which takes away about 5% of an investor’s return up front. The tracking error is also much lower than the Morgan Stanley China A Share Fund (CAF), which can often trade at premiums and discounts of as much as 10% to NAV for extended periods of time.
FXI is currently trading at a 1.71% discount to NAV, which is advantageous for a buyer and has a bid-ask spread of 0.880, which is a hidden cost to investing in it. Its 30 day average volume is 15.1 million shares, and its implied daily volume is 4.1 million shares, which means that it is fairly liquid for even high net worth investors. With a market cap of $5.05 billion, FXI reflects a growing interest of retail investors to avoid mutual funds like DPCAX, which charge excessive fees.