How to invest: Using ETFs to Invest in Asian Markets

Using ETFs to Invest in Asian Markets

Exchange-traded funds bought to gain exposure to China and Asia's emerging economies could make sense for some investors, if they're ready for bumpy markets that have recently endured violent boom-and-bust cycles, Japan's lost decade and currency crises.

The largest ETF in the Asian-stock category is iShares FTSE/Xinhua China 25 Index Fund (trading symbol FXI) with nearly $8 billion in assets. It is also one of the more liquid U.S.-listed ETFs with average daily volume of about 37.4 million shares over the trailing month, according to FactSet Research.

With its burgeoning middle class and solid export base, China is seen as a growing driver of the world economy. There are signs the Chinese economy is recovering faster than the rest of the world after the global financial meltdown.

The iShares FTSE/Xinhua China ETF tracks an index of the 25 largest and most liquid Chinese companies. All the stocks trade on the Hong Kong Stock Exchange.

"The fund's low correlation to the U.S. market make it a decent diversification tool, especially for investors with insufficient exposure to emerging markets," said Morningstar Inc. analyst Patricia Oey in a profile of the ETF.

"However, while investing in China may seem very attractive given the country's long-term growth outlook, we remind investors that Chinese stocks can be very volatile," she wrote.

With an expense ratio of 0.73%, the ETF offers "cheap and efficient exposure to the Chinese market, but the sector allocations may result in unbalanced exposure to various parts of the economy," notes Michael Johnston, senior analyst at ETF Database. Roughly 45% of the portfolio is concentrated in the financial sector, for example.

"There is concern that bubbles have emerged in the country's housing and stock markets, and a correction would certainly weigh on the performance of this fund, which has a significant weighting in the financials sector," Ms. Oey warned.

"If a global economic recovery proceeds slower than expected, the Chinese economy could face a hard landing in 2010 after a year of easy credit and government stimulus spending," she said, adding that political unrest is another investor risk.

Many other ETFs invest in China, including PowerShares Golden Dragon Halter USX China Portfolio (PGJ), SPDR S&P China ETF (GXC) and Claymore/AlphaShares China Small Cap ETF (HAO).

For traders who want to bet against the market, ProShares UltraShort FTSE/Xinhua China 25 (FXP) is a daily-leveraged ETF geared to profit when Chinese stocks fall.

Among other Asian single-country funds, iShares MSCI Japan Index Fund (EWJ) ranks as one of the largest with nearly $5 billion in assets. Japan's lost decade has made it tough on investors; through June 11, the ETF had a 10-year annualized return of negative 3.7%, according to Morningstar.

The iShares MSCI Pacific ex-Japan Index Fund (EPP) is another popular choice that covers the broader region. The $3.4 billion fund invests primarily in Australia, Hong Kong, Singapore and New Zealand.

"There are a few Asia region ETFs, which can be roughly divided into two subcategories—developed markets and emerging markets," Ms. Oey said. "A comparable developed market fund is Vanguard Pacific ETF (VPL), which has an attractive expense ratio of 0.18%.... but also includes Japan," she added. "For investors looking for Asia emerging markets exposure, we suggest iShares MSCI All Country Asia ex-Japan Index (AAXJ)."

SPDR S&P Emerging Asia Pacific ETF (GMF) is another emerging-market fund in the emerging markets category. It invests in China, Taiwan, India, Malaysia, Indonesia, Thailand and the Philippines.

Investors can further tailor their exposure to Asia with single-country funds such as iShares MSCI Malaysia Index Fund (EWM), iShares MSCI Singapore Index Fund (EWS), iShares South Korea Index Fund (EWY) and iShares MSCI Taiwan Index Fund (EWT).

The Asian-stock ETFs discussed here just scratch the surface of what's available.

Investors also have a wide selection of exchange-traded funds and notes that provide exposure to Asian currencies, including CurrencyShares Japanese Yen Trust (FXE) and WisdomTree Dreyfus Chinese Yuan Fund (CYB).  

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