The not-so-hidden dangers in the mania around the China Internet sector ETFs...
Most China ETFs have largely bucked the recent emerging markets sell-off, but there are a few funds producing impressive gains, especially those with the largest exposures to China’s “technology” sector.
But before investors get lured to these funds based on recent returns, it’s important to understand the reasons behind their outperformance, because some caution is warranted here.
For starters, it’s important to understand that the Chinese “technology” sector is still very nascent and largely consists of highly volatile Chinese Internet firms listed in the United States.
It’s also worth pointing out that the Chinese Internet sector has been red-hot in recent months for a few reasons, including the hype surrounding the upcoming initial public offering of one of the largest Internet behemoths on the planet, Alibaba.
For those chasing the hot money of Alibaba’s IPO, I can’t help but wonder if the tale of Facebook’s IPO and its aftermath might not be instructive.
But here’s a list of the 10 best-performing China ETFs of 2013 so far:
As you can see, two of the top three funds specifically target “technology.” But if you take a deeper dive into their holdings, you’ll notice that major Internet players make up over 50 percent of their weightings.
Then there’s the PowerShares Golden Dragon China Portfolio (PGJ | B-25) at the top—a broad-based China ETF that has gotten a lot of attention for its outperformance recently.
One might ask why this fund is performing so well.
The key to PGJ’s massive outperformance is due to the fund only being eligible to hold U.S.-listed Chinese securities. If you look under the hood, you’ll notice that seven of the top 10 holdings are major Chinese Internet firms that make up close to 50 percent of its weighting, even though it excludes Hong Kong-listed Tencent.
I also included two leveraged funds because the massive differences in their returns really shows the degree to which the underlying indexes matter. With China ETFs, the old adage “know what you own” is even more important, because not all China ETFs are created equally.
The Direxion Daily China Bull 3X Shares (YINN), which tracks an index made up only of American depositary receipts, is up more than 60 percent year-to-date. Meanwhile, the ProShares Ultra FTSE China 25 ETF (XPP), a double-exposure leveraged fund that tracks only the largest Hong Kong-listed securities, is down more than 10 percent year-to-date.
If you look at the returns in China’s major Internet companies in just the past three months, you’ll understand why these funds are so hot right now.