The secret to world stock market profits in China (hint: it beats Agricultural Bank of China)

On July 7, 2010, Agricultural Bank of China (AgBank) priced its first public share issue. The bank, which operates nearly 24,000 branches, will sell 25 billion shares on the Hong Kong Stock Exchange for HK$3.20 ($0.41 U.S.), and 22 billion shares on the Shanghai exchange for 2.68 yuan ($0.40 U.S.).

Strong investor interest in China, whose economy grew 11.9% in the first quarter of 2010 compared to a year earlier, should help AgBank’s initial public offering (IPO) raise $22.1 billion U.S. That would make it the largest IPO in world stock market history, topping Industrial & Commercial Bank of China, which raised $21.6 billion U.S. in 2006.

AgBank is the latest in a series of big world stock market IPOs from Asian and emerging markets this year. The world’s 10 biggest IPOs in 2010 include firms from China, Russia, Poland and India. The U.S. is noticeably absent from the list, and only one western European firm (from Spain) was included.

Investing in Agricultural Bank of China is not without risk

AgBank could well continue to prosper along with China’s economy, but the stock does entail definite risks.

For example, AgBank is mainly based in rural China. Rural-based banks generally face higher risks and lower returns than urban banks because rural clients often have less collateral for loans, and rural areas tend to have less stable employment than cities.

As well, like many Chinese banks, AgBank likely has a large amount of troubled loans on its books. That could hurt the bank if the Chinese government raises interest rates in the coming months to slow inflation.

Why new issues — especially foreign new issues — expose investors to extra risk

More generally, AgBank exposes investors to new-issue risk. That is, most new issues come to market when it’s a good time for the company and/or its insiders to sell, but that’s not necessarily a good time for you to buy. (For example, Chinese banks are attracting a lot of investor attention right now, mainly because of optimistic forecasts about the country’s economy.)

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New stock issues start out with a big marketing push. But when the initial hoopla ends, hidden risks can emerge. This can spur deep price declines in the new issue that go on for years.

Foreign new issues also increase your risk because you have to deal with exchange rates, foreign stock-exchange rules or language barriers. As well, many foreign countries, including China and other emerging markets, have weaker investor-protection laws than Canada and the U.S., and may also have less commitment to openness, fairness and so on.

This exchange traded fund offers a safer way of world stock market investing in China

Instead of foreign new issues like Agricultural Bank of China, we think you’re far better off investing in China through exchange-traded funds (ETFs), like the iShares FTSE/Xinhua China 25 Index Fund (symbol FXI on New York), one of the ETFs we cover in our Canadian Wealth Advisor newsletter.

High-quality international ETFs let you make world stock market investments with greater safety, and without the complications of directly investing in a foreign stock market.

iShares FTSE/Xinhua China 25 Index Fund aims to track the FTSE/Xinhua China 25 Index, which is made up of the 25 largest and most liquid Chinese stocks. All of the stocks in the index trade on the Hong Kong exchange. Some also trade as American Depositary Receipts (ADRs) on the New York exchange.

Plus, if you want exposure to AgBank, the stock will likely be added to the exchange-traded fund’s holdings soon after it begins trading on July 15.

Right now, the fund’s top holdings are China Mobile, 10.3%; China Construction Bank, 9.4%; Industrial & Commercial Bank of China, 8.0%; China Life Insurance, 6.8%; CNOOC Ltd., 6.1%; China Unicom Hong Kong, 5.0%; Ping An Insurance Group, 4.4%; China Petroleum & Chemical, 4.1%; PetroChina, 4.0%; and Bank of China, 4.0%.

The fund’s holdings give it the following industry breakdown: Financials, 45.6%; Telecommunications, 19.2%; Oil and Gas, 14.2%; Basic Materials, 9.4%; Industrials, 7.9%; Consumer Services, 1.8%; and Utilities, 0.8%. The ETF has an expense ratio of 0.73%. The dividend yield is 2.3%.

You can get our full analysis of iShares FTSE/Xinhua China 25 Index Fund and a number of other ETFs suitable for international investing in Canadian Wealth Advisor. Click here to learn how you can get one month free when you subscribe today.