ETFs To Hedge China

By Investopedia Staff | April 27, 2012 AAA

It seems that folks still can't let go of China despite the huge run up in stock prices over the past several years, but more importantly, the growing concerns regarding production overcapacity and credit expansion. As in the U.S., it is thanks to the help of the government that Chinese asset prices have recovered so well.

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Reasons to Stay
While investors should be extremely cautious entering China, the facts are that economic growth will likely still exceed most of the other countries around world in 2011 and going into 2012. While such growth is certainly aided by the Chinese government, it's no different here in the U.S. today. So it's not unreasonable to still have exposure to China. And despite recent market strength, names like agriculture company Yongye International (Nasdaq:YONG) and China Education Alliance (NYSE:CEU) are not expensive when the potential long-term growth rates are considered. Investors will need to dig deeper on these companies to see if they represent a buying opportunity.

Respect Mr. Market
Nevertheless, the best companies can see their share prices plummet when the overall market is in rapid decline mode. That's a mistake no investor wants to make again. One way to reconcile maintaining exposure to China while securing protection in the event of a sustained market decline can be done via two ETFs. The UltraShort FTSE China 25 Proshares (ARCA:FXP) is a leveraged ETF that will move at twice the inverse rate of the FTSE China 25 index. The other is the Direxion Daily China 3x Bear (ARCA:CZI), which, as the name implies, will deliver three times the inverse return of a broad basket of Chinese stocks. A very small position in either could be useful if the Chinese markets correct.

SEE: Investing In China

Handle With Extreme Care!
It's very important that investors understand that these are very risky instruments to employ. And because they are leveraged ETFs, even a downward move in China might not produce the anticipated result. If the underlying ETF benchmarks rise by 10%, FXI and CZI will decline by 20% and 30%, respectively. To get back to even, those ETFs would have to increase by 25% and 43%, respectively. These ETFs are designed for a rapid move in the desired direction.

SEE: Top 6 Factors That Drive Investment In China

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