How Do I Invest in Chinese Stocks?

Michelle Gibley, a director of international research with Charles Schwab, writes in "Why Invest Internationally" that international stocks tend to respond differently to market events than do other investment categories, such as small-cap stocks, and these markets offer unique growth opportunities. If you agree and want to adjust your portfolio risk by allocating a percentage of your portfolio in Chinese stocks, you have four options, including mutual funds and American depositary receipts.

Mutual Funds

As you place money into a mutual fund that invests in China, the fund pools your money with that of other investors to create a portfolio consisting of Chinese stocks, bonds or other securities. The fund's charter determines the diversification of fund assets. For example, a global fund invests in both foreign and U.S. companies. In turn, an international fund invests in companies that have operations in foreign countries, including China, and regional and country funds invest in companies in particular regions or countries. You can buy the funds from a discount brokerage firm, an investment advisor or a no-load mutual fund company. Advisors may charge an up-front or back-end sales charge for each individual transaction and/or mutual fund management expenses.

American Depositary Receipts

U.S. banks and brokerage firms issue American depositary receipts, which represent one or more shares of stock of a foreign company. The ADR and any dividend payments are denominated in U.S. dollars. The ADR is traded in the U.S. financial markets, which enable investors to avoid currency conversions and associated fees. However, the issuing financial institution, which holds the stock that is represented by the ADR, charges a small fee for providing this service. The price of the ADR equals the number of shares of stock that the ADR represents multiplied by the U.S. equivalent of the price at which the stock is trading on the foreign exchange. For example, assume a foreign stock is trading at 10 Euros per share, which, as of 2013, is equivalent to $1, and the ADR is worth 10 shares of stock. The ADR has an issue price of $10, or $1 multiplied by 10.

U.S. Traded Foreign Stocks

Foreign stocks are securities of companies based outside of the U.S., which are listed on the U.S. exchanges and denominated in U.S. dollars. The shares trade through brokers in the same way as domestic common stocks. Transaction costs may include custodial fees, transfer taxes, currency conversion fees and broker commissions. The stock's market value is determined by market, economic and monetary factors, including interest rates.

Exchange-Traded Funds

An exchange-traded fund is an investment instrument created by a financial institution to represent a collection of stocks that share particular characteristic, such as membership in the Standard and Poor’s 500. The financial institution creates the ETF by depositing a few million shares of stock the institution owns with a custodial bank. In exchange for the stock, the financial institution receives a creation unit. Each creation unit represents a block of ETF shares, which is usually 50,000 shares. The institution then trades the ETF shares on the stock exchanges like any other stock. An investor purchases the shares at market price using his brokerage account.