ECNS iShares MSCI China Small Cap

Although sentiment about China has been broadly negative, there have actually been plenty of sectors in the nation that have held up quite well. You might not have noticed this by looking at the country’s most popular ETF though, as FXI has fallen significantly in the past few months (see China ETFs Tumbling on Fears of Credit Crunch).

However, this fund is extremely concentrated in financials, one sector of the Chinese economy that has been hard hit by the recent woes afflicting the emerging economic giant. This has led some to consider new options for China ETF investing that go beyond just the mega caps and try to tap into more positive (and local) trends in the nation.

Enter KraneShares and Their First ETF

While a few have tried this approach in ETF form, the latest—and so far only China-exclusive ETF provider in the U.S.—is KraneShares. The firm has filed for several China-centric ETFs and recently made its first product debut with the CSI China Five Year Plan ETF (KFYP).

This unique ETF looks to invest in companies whose primary business (or businesses) will be important in the Chinese government’s current Five-Year Plan. This interesting approach thus looks to align its holdings with the economic and social priorities of the Communist Party of China, and their near term plans for the nation.

Five Year Plan in Focus

The Five Year Plan is arguably the most important and guiding document for Chinese domestic policies over a half decade period. The 12^th such plan—which is for the period of 2011-2015—was recently put into place, shining plenty of light on China’s priorities for the next few years.

In the plan, there was clearly a focus on rebalancing the Chinese economy and to put a greater emphasis on consumption. This could help the country to become less prone to outside shocks, and to make China more self sufficient from an economic perspective as well.

Beyond that, there was also a definite focus on technology, specifically in terms of the internet and the transformative effect this has—and will continue to have-- on the nation. Due to this there has been more talk of developing high tech hubs, and diversifying the economy more into technology services (also see China ETFs Surge on Premier’s Growth Pledge).

Another big aspect of the latest plan was on urbanization and energy use. As China becomes more urbanized, this will put more strain on the nation’s infrastructure, forcing more investment in this key area of the nation. However, this won’t be all, as clean energy also looks to play an important role in alleviating some of the concerns over pollution in urban areas, as well as mitigating worries over high oil prices as well.

KFYP ETF Under the Microscope

In order to play this trend, this ETF looks to skew towards many of the industries highlighted above, while forgoing sectors that, while important in previous plans, are unlikely to be a focus during this time frame.

The resulting portfolio is heavily skewed towards technology companies (36%), followed by consumer discretionary (16.6%), and industrials (15%). Staples (14.6%) also receive a solid allocation, while materials, utilities, and health care round out the rest of the portfolio, leaving nothing for industries like financials or telecoms.

In terms of individual holdings, Tencent (14%), Baidu (13%), and Want Want China (3.2%) are the three biggest weightings. It is also important to note that the product is mostly focused on Hong Kong listed firms, though it also includes ADRs of companies based in China as well (also read China ETF Investing 101).

For expenses, the product is in line with many other China ETFs, charging investors 68 basis points a year in fees. Still, the product, due to just having been launched, will likely have little in assets and volume for the time being, so bid ask spreads may be wide, at least initially.

ETF Competition

KFYP could be an interesting choice to play the second largest economy in the world, and in a way that could be underrepresented in many portfolios thanks to traditionally large weightings in sectors like financials and energy in other China ETFs.

There are a few interesting competitors to this fund though, as a couple other products on the market also avoid big weights to sectors like financials and energy. In particular, the relatively popular PowerShares Golden Dragon China Portfolio (PGJ) could be a foe with its nearly 55% allocation to technology.

Beyond that, there are several small cap focused products which also offer up minimal allocations to sectors like financials or energy, including HAO from Guggenheim, and ECNS from iShares. These have seen a decent level of popularity too, though all have failed to capture the high level of interest that is in the FXI product (also read The Right and Wrong Ways to Invest in China ETFs).  

It is important to remember that all of these products, unlike KFYP, will likely continue to focus on the same sectors year in and year out. The KraneShares product, however, will shift as the Five Year Plan priorities change in years ahead, suggesting that it may not always line up with these other, more entrenched competitors.

Bottom Line

This is a rough time to launch a China-focused ETF, given the broad concerns over the country’s growth rate and economic health. This is particularly true if debt concerns continue to bubble up, or if the nation faces trouble in getting new stimulus measures to boost the economy.

However, KFYP may be relatively unscathed by these issues and could be a better pick for investors seeking some China exposure in their portfolios. This is thanks to its focus on important sectors that the Chinese leadership is shining the spotlight on, suggesting that this fund may be worth a closer look for those willing to bet on the Chinese market now.

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ISHARS-MS CH SC (ECNS): ETF Research Reports
 
ISHARS-CHINA LC (FXI): ETF Research Reports
 
GUGG-CHINA SC (HAO): ETF Research Reports
 
KRANS-C CHN 5YP (KFYP): ETF Research Reports
 
PWRSH-GL DR HA (PGJ): ETF Research Reports
 
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