Index funds have long been a Foolish way to gain instant, low-cost diversification without worrying about timing the market. Their ease and convenience may explain the growing popularity of exchange-traded funds -- mutual funds that trade like stocks. According to the Investment Company Institute, ETF assets totaled more than $596 billion of the more than $1 trillion in stock index funds as of April 30 -- a 28% increase over last year, and up $25 billion from March.

Originally modeled after index funds, ETFs have gradually narrowed to target specialized slices of the market. While that's a boon to investors seeking specific investments, it also concentrates the risks of specialization, tilting a portfolio away from the diversification that makes index investing attractive.

Today, we're looking at the exchange-traded funds that focus on Chinese markets. While last week we looked at ETFs from Latin America, where economies remain surprisingly strong -- it was the only region in the world to post gains for the first half -- China's poor showing is reported to be because of government controls to cool off the superheated economy at the end of December. Certain industries may fall further because of recession here in the U.S. and elsewhere, but China's domestic economy is still expected to grow 10% this year.

We'll then combine that information with the collective intelligence of the 110,000 professional and novice investors at Motley Fool CAPS to see which funds our participants have rated as the best.

ETF

Net Assets

YTD Return

3-Year Return

CAPS Rating

iShares MSCI Taiwan

$3.4 billion

(11.8%)

10.7%

*****

iShares FTSE/Xinhua (NYSE:FXI)

$5.3 billion

(19.2%)

146.8%

***

iShares MSCI Hong Kong

$1.7 billion

(24.4%)

33.7%

*****

SPDR S&P China

$429 million

(27.7%)

88%

***

PowerShares Golden Dragon Halter U.S. Index China

$149.3 million

(23%)

NA

****

Source: Yahoo! Finance. CAPS Ratings courtesy of Motley Fool CAPS. Return's as of June 18. NA=not available.

Tread carefully with ETFs, Fools; while the market offers many exchange-traded funds, few have a long history. Not all of our ETFs this week have a three-year return history -- arguably a key milestone -- so only time will tell whether they can continue building a solid track record over longer periods.

A strategy that pays dividends
If China's domestic economy is still growing, albeit at a somewhat slower rate, which companies might best be able to capitalize on those trends? According to the market researchers at CCID Consulting, digital TV will promote a new round of growth in China's integrated circuit industry over the next five years. AU Optronics (NYSE:AUO) is a Taiwan-based manufacturer of LCD screens that sells TFT-LCD displays to original equipment manufacturers in both Taiwan and on the mainland. While 46% of its revenues comes from the notebook computer market, another 42% comes from television. And although only 9% of its sales were from various consumer electronics such as mobile handsets, it's a more stable market for AU Optronics than computer sales, and its unit sales rose 81% year over year. That kind of trend might also pay off for mobile phone service provider China Mobile (NYSE:CHL) in a country that had 547 million users and growing at the end of 2007.

With the interconnectivity offered between computers and cell phones these days, Internet offerings like service providers China Netcom and China Telecom (NYSE:CHA), along with giant Internet search company Baidu.com (NASDAQ:BIDU), should also stand out.

Although many of the exchange-traded funds focusing on China include large oil interests like CNOOC (NYSE:CEO) and PetroChina (NYSE:PTR), only the iShares MSCI Taiwan Index has AU Optronics among its top 10 holdings and only the PowerShares Golden Dragon Halter USX China gives you exposure to the others that may benefit from AU Optronics' business.

Of course, not everyone is convinced that these will be the highfliers of the future. Investors like CAPS member BenStyles finds that a company like Baidu.com could be yesterday's dot.com bust, like AltaVista.

This stock is poised to crash as equity investors realize that a p/e of 129 is just ridiculous for a company that can be eclipsed. [Baidu.com] could as easily be the Chinese Yahoo as the Chinese Google. Or the Chinese AltaVista?

Others, though, find the prospects for LCD maker AU Optronics to be exceptionally bright, and CAPS member Bugshu looked at its valuation back in April and saw an incredibly cheap opportunity.

With a forward looking P/E this stock is fabulously cheap [relative] to its growth prospects in the strong growth industry of LCD screens. It is unloved and undiscovered by the street which has focused on the aspects of its commodity pricing rather than rewarding the growth of the industry as a whole ... [AU Optronics] is probably the best managed player in the field right now based on their ability to establish customer loyalty, produce a great product, and manage costs. [AU Optronics] is a true technology stock in the midst of a growth phase that should last for years with a 2008 P/E under 5. And [that's] as cheap as you will ever see a company [that's] posting up solid 20% growth [quarter after quarter].

A basket of opinions
Although ETFs have been around since the 1990s, investors should exercise caution with any ETF lacking a long track record. Over on CAPS, let us know whether you think these ETFs will continue to outperform, or whether it's time for new ones to top the lists.

Baidu is a Rule Breakers recommendation and CNOOC is a Global Gains pick. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Duprey does not have a financial position in any of the funds mentioned in this article. You can see his holdings. The Motley Fool has a world-class disclosure policy that has been around the world and back again.