Slowdown in China: Watch These ETFs

As you've probably heard, signs of a slowdown are coming from the most important emerging-market nation, China. Weak February trade numbers showing a $23 billion trade deficit -- the biggest in two years -- are raising some concerns among investors.

As a consequence, big financial institutions lowered their China GDP growth forecast for the first quarter and full-year 2014. Bank of America Merrill Lynch, for example, reduced its first-quarter GDP growth forecast to 7.3% from 8% and its annual growth forecast to 7.2% from 7.6%.

You may not think that's a significant cut, but this could be the first sign of a slowdown coming to the country.

Key indexes
Trying to understand what's happening and where to invest in China is not easy. But in order to get a better view of what's going on in the country, start by looking at the country's stock indexes. A good one to follow is the Harvest CSI 300 index, which is composed of the largest and most liquid stocks listed on the Shenzhen and Shanghai Stock Exchange, also known as the "A" share market.

The index dropped to five-year lows after the trade numbers were released. Now, according to data compiled by Bloomberg, the CSI 300 is trading at 7.7 times projected 12-month earnings, the lowest level since 2007. So the index made a correction, but could it be a temporary overreaction? After all, the trade numbers reflect some distortion as a result of the inclusion of Chinese New Year trade figures, making year-over-year comparisons unfavorable.

If you buy this thesis, you might want to go for two ETFs that track this index: Db X-trackers Harvest CSI 300 China A-Shares (NYSEMKT: ASHR  ) and Market Vectors China (NYSEMKT: PEK  ) . Keep in mind that both of these funds have dropped significantly this year, losing 9.6% and 12.2%, respectively.

One interesting thing about the CSI 300 index is that it does not track Chinese megacap names like China Mobile (NYSE: CHL  ) , CNOOC (NYSE: CEO  ) , and Baidu (NASDAQ: BIDU  ) , as they are not listed in mainland China. Thus when you invest in these two funds, you will have significantly lower weightings in the telecom, energy, and technology sectors, and consequently a relatively high weighting in financials, industrials, materials, and consumer goods.

However, funds' allocations bring certain risks. Db X-trackers Harvest CSI 300 China A-Shares and Market Vectors China allocate 36% and 39%, respectively, to the financial sector, which is normally the first one to correct in market slowdowns.

Another index
There's another index that covers the Chinese "A" share market, MSCI China A IMI, and a recently launched ETF that follows it, KraneShares Bosera MSCI China A (NYSEMKT: KBA  ) .

This fund allocates 32% to the financial sector -- a bit less than the other two but still worrisome, given the uncertainty. Industrials is the second-largest sector at 16%, followed by consumer discretionary at 12% and materials at 9%. The fund is very light on technology stocks at just 5%, in line with the other broad-based funds.

In addition, the KraneShares Bosera ETF has 50% more holdings than the other two ETFs, giving it broader coverage and more diversification, which could make it more stable.

Some Foolish thoughts
Despite the differences in year-to-date performance, there's a high correlation between the three funds.

Market Vectors China and db X-trackers Harvest CSI 300 are more tilted toward the financial sector, making them a bit less attractive in the current scenario. Chinese financials remain in decent shape, but investors see short-term risk.

From a longer-term point of view, if you expect more consumer-driven Chinese growth, KraneShares Bosera could be a better option, as it should get a boost from its slightly larger position in industrials.

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