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Fund Spy

New China, Sector ETFs Offer Promise and Peril

Taking stock of recent launches and developments among ETFs.

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Efforts to expand the menu of exchange-traded funds and make them more accessible to smaller investors have received a lot of attention recently. Some of the more prominent new funds include the first mainland China ETF and several new Vanguard sector ETFs. Meanwhile, two firms claim they have found ways to make ETFs more affordable for those who want to make regular monthly investments. A closer look at some of these new funds and developments shows there is something to the hype, but also reason for caution.

The China Syndrome
The iShares FTSE/Xinhua China 25 Index Fund (FXI), which tracks an index of 25 large Chinese companies, has been hailed as the first ETF to offer exposure to stocks on the Middle Kingdom's mainland. Its attractions are clear: There aren't many mutual funds offering pure exposure to China, and this ETF's 0.74% expense ratio is much cheaper than all of them. The China 25 ETF also provides an easier way to negotiate China. Heavy government ownership of many enterprises, a thicket of company share classes, and boom-town atmosphere make it a daunting place to research and pick stocks.

The ETF's dangers are just as apparent. Political and economic uncertainty, as well as extreme portfolio concentration are sure to make the fund volatile. China has been a huge impetus for global growth, but it's still a communist country that faces questions about the sustainability of its expansion, corporate governance of its firms, and integrity of its property rights. With about two dozen holdings, this ETF's bogy also is focused and top-heavy. The fund keeps nearly 60% of its assets in its top 10 holdings and a similar amount in just three sectors: energy, telecommunications, and industrial stocks.

Dan Culloton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.