How to use FXI for diversification

(Sept. 17, 2009 - Chinavestor) Diversification is key in successful investing. If you want to lower or practically eliminate company specific risk, ETFs are a way to go. Besides giving you diversification right away, they offer tax and trading cost advantages, in addition.

One of the first Chinese ETFs come to the U.S. was the iShares FTSE/Xinhua China 25 Index (NYSE:FXI). And while this ETF has been fired at from all sorts of directions, I still believe this is a great investment vehicle and should not be overlooked. Here is why.

An article keeps coming from the Motley Fool with the same content every time - The wrong way to invest in China. According to the author "By investing in FXI, you're not sufficiently tapping into the entrepreneurial spirit of the Chinese people. See, FXI tracks a FTSE/Xinhua index mainly comprising state-owned enterprises (SOEs). In fact, of the top 10 holdings of the exchange-traded fund, 10 areSOEs (or are subsidiaries of SOEs, which for my purposes are one and the same)....

The problem is that historical data suggest differently. The following chart proves Motley Fool dead wrong when it comes to actual performance. This chart compares the iShares FTSE/Xinhua China 25 Index (NYSE:FXI) to the Claymore/AlphaShares Small Cap China ETF (NYSE:HAO), the most entrepreneurial spirited China ETF, since her inception.

HAO_FXI

So much of FXI being the underdog...

Another writer was complaining about the composition of the FXI, saying that it is financial heavy weight and thus should be ignored. While the fact is true the conclusion is dead wrong just as well.

Think about this: if you're an American investor trying to build a diversified Chinese portfolio, you're short handed when it comes to Chinese financials. While China has great financial institutions, actually one of the largest in the world, none of them are listed in America. Industrial and Commercial Bank of China (ICBC), the largest Chinese lender, has a market cap of over $300 billion in Hong Kong. All four largest Chinese banks are listed in Hong Kong and/or Shanghai, yet none in the U.S.

So if you want to add Chinese financials into your portfolio, FXI - a financial heavy weight - is the best way to go.

iShares FTSE/Xinhua 25 Index (NYSE:FXI) Portfolio Allocation as of 1/31/2009

FXI_allocation