How to Make Money Investing in China

Should You Invest in China?

Many of our readers have asked us whether or not they should consider investing in China, and if so, what is the best way to go about it. The answer to the first question is yes. In today’s global economy, every investment portfolio should own foreign investments, including some from emerging markets. While China fits into the category of emerging markets, the size of their GDP makes them the 3rd largest economy in the world behind the US and the Eurozone. While there is always risk in emerging market investing, buying Chinese stocks is definitely not the same as buying stocks in smaller, third world nations.

The opportunity for growth in China far outweighs that of the US and other established economies of the world. Even though their economy has been slowed by the worldwide recession, China’s GDP still grew 8.7% in 2009. GDP growth of 8.7% would be considered a booming economy in the US. From 1947 until 2010 the United States' average quarterly GDP Growth was 3.31% reaching an historical high of 17.20% in March of 1950.

The Best Way to Invest in China

Now that we’ve established that there are great opportunities for growth in Chinese stocks, the question becomes how to invest. The answer to this will vary depending upon your risk profile, but we’ll address how the average retail investor should invest in China. While there are several dozen Chinese stocks trading on the US stock markets as ADRs, we recommend buying a basket of stocks, rather than trying to pick individual companies. The easiest and most cost effective way to do this is through the purchase of exchange traded mutual funds, or ETFs.

The four ETFs that we would recommend are HAO, PGJ, EWH, and FXI. We’ll give more detailed descriptions of each fund and their performance returns below. We’d recommend breaking your China investments into thirds, buying 3 different ETFs. We’d put 1/3 into HAO, which is a Chinese small cap growth fund, 1/3 into PGJ, which invests in US companies that derive the majority of their revenues in China, and the final 1/3 into either EWH or FXI. Both EWH and FXI a blend of large cap Chinese value and growth stocks. We recommend one or the other because they have a lot of similar holding, and industry breakdowns. If we had to choose one of them, we’d go with EWH because it has a bit more diversification than FXI.

HAO is the Claymore/Alpha Shares China Small Cap Index Fund. As it’s name indicates, the focus of the fund is to invest in Chinese small cap growth stocks. The fund was started on 01/30/2008 and has assets of $431 million. As of 10/06/2010, it had a year-to-date return of 4.54% and a staggering 1-year return of 98.86%. Obviously, those returns show that this fund has been quite a roller coaster ride.

PGJ is the Powershares Golden Dragon Halter USX China Portfolio. The fund buys stocks of US companies that derive the majority of their revenues from China. This fund appeals to many because while it give you the opportunity to take advantage of the growth of the Chinese economy, you’re buying stock in American companies. The downside is this isn’t a pure play on China. The fund has net assets of $346 million, and a 5-year average annual return of 11.60%.

FXI is the iShares Trust FTSE Xinhua China Index Fund. It is a blend of Chinese large cap value and large cap growth stocks. The fund tracks the 25 largest Chinese companies and has assets of $4.6 billion. Since it tracks the 25 biggest companies, regardless of industry, the fund is over weighted in financials. This can be good over the long term, but it can also make for a bumpy ride in the short term. The 5-year average annual return for FXI is an impressive 15.86%.

EWH is the iShares MSCI Hong Kong Index Fund. EWH is designed to track the overall Hong Kong stock market. Like FXI, it is a Chinese large cap blend fund. Also like FXI, EWH is over weight in financial stocks. However, it does have a better level of diversification than you’ll find with FXI. EWH has assets of $2 billion, and a 5-year average annual return of 7.59%.

China is currently in a growth stage similar to the post-war United States of the 1950s with one major difference. Today’s Chinese population is nearly 10 times what the population of the US was in 1950. That is a huge economic engine that can produce profits for decades to come.