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China Petroleum & Chemical Corp (ADR) (SNP), PetroChina Company Limited (ADR) (PTR): Significant Risks in Passive Chinese ETFs

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Passive, index-tracking exchange-traded funds are in huge demand — but are they always wise investments? The WisdomTree China (NYSE:SNP) Dividend Ex-Financials Fund is an example of an index fund with a lot of unnecessary risk–the index it follows is based on investing in Chinese dividend-paying stocks. The year-to-date return is -5.08% and a dividend has yet to be established or paid (see the price chart below).

Some of the risks I see are as follows: currency translation, accounting style differences, political risks, and basic cultural differences.

Foreign companies conduct business measured in their own currency and accounting formats. After a foreign corporation has undergone extensive investigation and applied procedures applicable to our markets, shares are available for trade in the US. Such shares are called American Depository Shares (ADS). These are claims to foreign shares and reflect the currency translation in the value. ADSs have foreign currency risk embedded. Reports that are issued in the home currency and format may further cloud actual financial and operational performance. See the Chinese yuan exchange rate price chart and the ETF share price chart below.

The first position in the WisdomTree China Dividend Ex-Financials Fund is China Mobile Ltd. (ADR) (NYSE:CHL). This ADS has posted a one-year return of 2.13% and represents an 8.1% position, as of May 1, for this ETF. The price below indicates range-bound trading for the past year and the volatility seems to be declining. Regarding earnings, what is available is a gross figure labeled profit attributed to equity shareholders expressed in renminbi billions. The amount for the first quarter of 2013 is 27.88 and first quarter of 2012 reported 27.8. The outlook for the Chinese mobile phone market appears to be strong. As a stand-alone investment, China Mobile Ltd. (ADR) (NYSE:CHL) offers some great long-term promise — provided the effects of currency translation can be reduced to a manageable level.

Following this holding in the WisdomTree China Dividend Ex-Financials Fund is China Petroleum & Chemical Corp (ADR) (NYSE:SNP). This ADS has given a one-year return of 16.35% (see the price chart below). This is an example of difficulty in accessing timely information. The most current information on the company website is the 2012 annual report. The year ending Dec. 31 reports diluted earnings per share at 0.704 renminbi and for 2011 at 0.795 renminbi. Forward-looking comments made by the chairman talk about taking efforts to improve internal operations and resolve organizational issues that have created inefficiencies. From a single stock to consider, I would not choose this one. There seems to be a veil of secrecy surrounding this company and any information that I would review may not be timely or say a lot.

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