iShares FTSE/Xinhua China 25 Index (ETF) (FXI)

Reloading here. I sort of question whether the FXI will unerperform the S&P 500, but I know very well that there are 500 good ways to invest in China and this isn't one of them.





Too many people confuse the FXI with a way to invest in Chinese growth. It isn't. FXI was set up by the Chinese government and is a set of 25 Chinese State Owned Enterprises (SOEs), with the pot sweetened a bit with the inclusion of PetroChina.





Launching FXI was little more than a public relations move by the Chinese government, and they include mostly second tier SOEs, which as a group are not run by entrepreneurs who are delivering the sizzling growth rates seen in China. Investors should, for the most part, stay away from Chinese SOEs, and yet most American fund managers do just that. China's growing in spite of these dinosaurs, not because of them.





SOEs have traditionally been the dominant component of the Chinese economy, and they tend to be headed by executives that are part bureaucrats hand picked by the government and without any responsibility to shareholders. These people have not been selected based on their ability to manage -- they are being rewarded for loyalty and patronage to the Party. One outgrowth of this fact is that many SOEs have leadership which does not draw boundaries between the company's finances and their own. Throughout Beijing you'll find "princelings" driving around in expensive cars, consuming prodigious amounts of wealth on the back of the SOE that they or their family runs. These people are untouchable.





China is growing despite the SOEs (and there are a few well-run ones, like CNOOC and PetroChina). In 1980 there were 300,000 SOEs, which made up 80% of the country's economy. Now there are fewer than a third that amount, and they comprise about 30% of GDP. The government keeps many of them alive by infusing them with capital -- and one of the ways that they've done so is by -- ta daaaa!!! -- taking them public.





These companies generally lack any sort of transparency, their accounting is a shambles, and they are going to get crushed by the entrepreneurs in China who are actually driving the country's astounding rate of growth. The only reason to invest in SOEs is to find the ones that have special status that the entrepreneurial companies will not be able to ford. But one will do much better investing in the companies than investing in a basket that has a few speedboats and 18 anchors. That's what FXI is, and it's why, during the height of the Shanghai stock market bubble, I said, with confidence, that the outcome was "not in doubt." Garbage doesn't float forever, and when the Chinese government finally opens up its investing regime so that Chinese citizens can choose to invest beyond Chinese companies, the thesis on FXI will be dependent on little more than the proclivities of the retail Chinese investor to become overenthusiastic about today's answer to Dutch tulips.





This is a copy of the update on my rating on FXI on my own CAPS page, but I thought that your reply warranted special attention. I'm getting ready to head back to China to talk with some of the real drivers of the Chinese miracle. Some day there will be a good Chinese ETF, based on its growth engine companies. This isn't it. It's a public relations and a capital raising ploy.





Buying FXI to take advantage of Chinese growth is like buying cow chips because you like steak. Sure, there's some value in there, but who wants to dig through that other stuff?