In Emerging Markets, the Smaller the Better: Petroleo Brasileiro Petrobras SA (ADR)(PBR), iShares MSCI Brazil Index (ETF)(EWZ)

The Case for Chinese Small Caps

iShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI) is the biggest and most popular ETF for China investing, but it hardly seems like the best alternative considering that the instrument tracks an index composed of 25 mega capitalization stocks with a heavy tilt towards sectors like financial services, communications and energy.

Not only is the degree of diversification insufficient, but most of the holdings are in sectors where political interference and state ownership are big problem to consider. Besides, the ETF excludes sectors like industrials, consumer and technology which are perhaps the most promising when considering China and its long term growth prospects.

For this reason, an alternative like Guggenheim China Small Cap may provide a superior choice for investors looking for a better risk and reward equation when it comes to investing in China. The instrument holds nearly 250 individual stocks, and it’s much more diversified in terms of sector exposure. Besides, by being focused on smaller companies, this ETF avoids the drawback of excessive exposure to estate owned companies.

Bottom Line

Smaller companies are usually believed to be riskier than big capitalization stocks, but things can be the other way around when we consider political risks and government intervention in emerging markets. In these particular geographies, smaller names can provide both better growth opportunities and less risk.

The article In Emerging Markets, the Smaller the Better originally appeared on Fool.com and is written by Andrés Cardenal.

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