What you need to know about exotic Chinese ETFs

A casual survey of the ETF marketplace reveals 17 separate exchange-traded products that concentrate on Chinese stocks. Many promise exposure to theoretically exciting investment themes, but for most, realizing that promise still carries significant risk.
The sad truth is that while the creativity of the ETF industry seems inexhaustible, investors’ appetite for fine-tuning their portfolios to take advantage of sector drivers has lagged far behind.
As a result, many funds created to fill a specific investment niche or embody a specific theme have had a hard time generating the investor interest they need to boost their overall assets and daily turnover.
This in turn creates a vicious cycle as institutional investors looking for an ETF big and liquid enough to handle even a sliver of their money opt for the entrenched leaders — whether the portfolio is a perfect match for their investment objectives or not.
The China group of ETFs perfectly illustrates this process of the “big getting bigger”. Each of the 17 funds in the category invests more than 80% of its assets in Chinese stocks, and together they turn over about 17.45 million shares a day.
But instead of each fund moving 1 million shares a day, the heavyweight — the large-cap iShares FTSE 25 China fund (FXI, quote) — accounts for a staggering 96% of all the volume in the group.
With only 4% of overall liquidity left for everyone else to fight over, even relatively successful funds like the China SPDR (GXC, quote) have had a gruesome time accumulating assets.
And whether you are looking for something more exotic than the leader or are simply unhappy with the way it invests its funds, you have an equally gruesome choice of seeking out a small and relatively illiquid fund or swallowing your qualms and sticking with the leader.

A lot of traders tell me they hate FXI as a proxy on China because 52% of the portfolio is devoted to the financial sector and more than half of that allocation is divided among just four huge — and nebulous — banks.
GXC is a far less concentrated China play with “only” 30% of its money tied up in financial stocks, so those willing to give up the benefits of an active trading strategy may be happier here. 
Beyond GXC, the only full-spectrum China ETF that generate daily turnover above 100,000 shares is the MSCI China Index (MCHI, quote), which looks a lot like a slightly bank-heavy version of GXC at a marginally higher expense ratio.
Among the more specialized funds, turnover drops even more dramatically.
The Guggenheim China Small-Cap (HAO, quote) and China Consumer (CHIQ, quote) are the exceptions, indicating that when emerging market traders break away from FXI hegemony they prefer to dig under that admittedly large-cap and export-heavy fund to get at the actual Chinese middle class.
Everything else offers a tempting story but not much juice for those who need to be able to buy or sell in a hurry: the INDXX China Infrastructure Index (CHXXquote), China Energy (CHIE, quote), China Financials (CHIX, quote), China Technology (CQQQ, quote) and its NASDAQ-derived analogue (QQQC, quote), China Industrials (CHII, quote) and China Materials (CHIM, quote) barely move 60,000 shares a day between them.

Depending on the portfolio and your investment strategy, any of these funds can still play a vital role. They may not support the go-go trading tactics that make ETFs special, but they often provide access to Chinese companies that simply aren’t available to U.S. retail investors anywhere else.
Yes, this means that these “illiquid” ETFs should probably be considered more like classical mutual funds until turnover picks up.
But in the meantime, they do have one advantage over nearly all China mutual funds: they’re cheap. The most expensive China ETF, CHXX, charges 0.85% a year, while most others in the group have found ways to keep their expense ratios in the 0.60% to 0.70% range.
The cheapest China mutual fund in the Morningstar data base, ING Hang Seng Index (IHPIX, quote), carries an expense ratio of 0.77%, and from there it’s a steep slope to portfolios that take 3% and more of investors’ money every year just for the privilege of investing.