A recent article from Bloomberg highlights the central issue.  And that is, many of these loans are “backed by collateral that is overvalued, may be hard to sell and, in some cases, doesn’t exist.” If this sounds familiar, think “Lehman” back in 2008.  Virtually all of China’s major banks are holding this paper, and many US ETFs and funds hold stock in these banks. One analyst cited by Bloomberg assumes that as much as $900 billion or so will not be repaid.

We’ve taken a look at some ETFs and mutual funds that hold shares in major Chinese banks. These funds include iShares FTSE China 25 Index Fund (NYSE: FXI), SPDR S&P China ETF (NYSE: GXC), PowerShares Golden Dragon Halter USX China ETF (NYSE: PGJ), Matthews China Investor (MCHFX), Fidelity Advisor China Region A (FHKAX), and Templeton China World A (TCWAX). All data on the funds is taken from Morningstar.

The iShares FTSE China 25 Index Fund (NYSE: FXI) holds 100% of its $6.7 billion in assets in Chinese equities. Just over 50% of the fund’s holdings are in financials, with more than half that invested in China Construction Bank, Industrial and Commercial Bank of China, Bank of China, Ltd., and Ping An Insurance Group, all Hong Kong-traded equities. The fund holds no real estate stocks. The ETF gets a 2-star rating from Morningstar.

The SPDR S&P China ETF (NYSE: GXC) holds more than 99% of its $772 million in assets in Chinese equities, and about 27% in financials. Its investments. Two-thirds of these holdings are in the same three banks, with China Life Insurance Co. Ltd. replacing Ping An. The fund holds about 3.8% of assets in real estate stocks. The ETF holds a 3-star rating from Morningstar.

The PowerShares Golden Dragon Halter USX China ETF (NYSE: PGJ) holds about 97% of total assets of $370 million in Chinese equities, but only about 5% in financials. Only China Life is included in its top ten holdings at 4.4% of assets. The fund holds less than 1% of assets in real estate stocks. The ETF holds a 2-star rating from Morningstar.

The Matthews China Investor (MCHFX) tracks the MSCI China Index and holds 100% of its $2.8 billion total assets in Chinese equities. About 18% are invested in financials, approximately half the exposure to the financial sector as the Index itself. Only Ping An is included in the fund’s top ten holdings. The fund’s largest investment sector is the consumer discretionary sector, at nearly 27% of assets, more than 4 times the Index holdings. Real estate holdings total about 4.75% of assets. The fund holds a 5-star rating from Morningstar.

The Fidelity Advisor China Region A (FHKAX) holds nearly 98% of its $2 billion total assets in Chinese equities. Financials make up about 30% of the holdings, with the three large banks accounting for almost 10% of holdings. The fund holds about 7.5% of its assets in real estate stocks. The fund holds a 3-star rating from Morningstar.

The Templeton China World A (TCWAX) holds about 99% of its total assets of $1.2 billion in Chinese equities. About 12.5% of holdings are financials and about 3.7% are real estate stocks. About 6.4% of holdings are shares in Bank of China and China Construction Bank. The fund holds a 5-star rating from Morningstar.

The three ETFs we’ve noted have done no better than stay flat since the beginning of the year. Of the mutual funds only TCWAX is showing a gain for the year.

Accounting issues and bad loans are not new to China. In 2003, when China Life issued shares on the NYSE, the company admitted accounting irregularities totaling $650 million. In the same year China’s biggest banks held an estimated $500 billion in bad loans, most of which the government covered in a massive recapitalization program. Even then the big problem was soaring real estate prices.

The difference was the real estate in question. In 2003, the boom in property was occurring in Shanghai and Beijing. Now, it has moved out to the sticks into cities few people outside of China have ever heard of.

It is pretty unlikely that the Chinese government will let its biggest banks fail. But to rescue them could put the brakes on China’s economic growth. The country’s financial, consumer, and real estate sectors could all suffer significant damage, with the effects rippling through the entire economy.

What happened in the US following the Lehman implosion is on the brink of happening in China. When (not if) it does, the best the country can hope for is that the government has taken the proper steps to ensure a soft landing. So far, there’s not a lot of evidence for that.

Paul Ausick

24/7 Wall St. looked at the "Best Funds" lists of the publications that have for years devoted a tremendous amount of their editorial effort to evaluating mutual funds. We conducted a "meta-data" study to find out which funds were on more than one list. The number was very small.

Forbes, Money, Smart Money, and Kiplinger do not have much in common in the ways they measure performance. Some of the ratings are based on simple one-year returns. Others weigh in multi-year performance. Still others look at performance volatility. Some funds are measured on how they will fit into a portfolio mix to drive the best and safest long-term pay-back.

Here are the nine funds that made more than one list

Matthews China Fund (MCHFX) Designed to be a long-term China investment which keeps over two-thirds of its capital in securities from that country. On the Smart Money and Forbes lists.

CMG Focus (CGMFX)  Long-term appreciation focused and tends to invest in equities of a small number of companies at any one time. On the Forbes, Smart Money, and Kiplinger lists.

Harbor Bond International (HABDX) Invests for total return, primarily in corporate and government bonds in the US and overseas. On the Money and Kiplinger lists.

T Rowe Price Equity Income (PRFDX) Invests in well-established companies with higher than normal yields. On the Money and Kiplinger lists.

Dodge & Cox International (DODFX)  Invests for principle and income growth with 80% of assets from outside US. On both the Money and Kiplinger lists.

Fairholme Fund (FAIRX) Invests in no more that 25 equities at one time. May take positions in convertible preferred shares. On Kiplinger and Money lists.

T Rowe Price Emerging Markets Stock (PRMSX) Invests for long-term growth of capital. Eighty percent of investment in emerging markets in Asia, Latin America, and Middle East. On Kiplinger and Money lists.

Oakmark International (OAKIX) Invests in common stocks of companies in at least five countries outside the US at any one time. On Money and Kiplinger lists.

Muhlenkamp (MUHLX) Buys stock and fixed income in companies it believes are undervalued. On both Money and Kiplinger lists.

Additional fund description data from Money.

Douglas A. McIntyre

.

.