Mutual Funds That Invest in Chinese Rare Earth Companies

Niche market stocks can spice up a portfolio with their potential for wider price swings due to small market size and concentration of products and services. The market for rare earth companies offers the bonus of dealing in products needed in fast-growing high-technology fields. But picking companies in small markets like rare earth products is tricky for the average investor. A better course may be to invest in funds in that sector to spread investment among a number of companies.

Rare Earth Sector

There are 17 rare earth metals, so called because they are difficult to find in sufficient quantities to mine profitably. Various rare earths are essential in production of numerous hi-tech products, from cell phones to steel alloys. Some 95 percent of rare earth mining output comes from China. Funds featuring rare earth companies would seem to give us an ideal shot at profiting from growth in high technology and China -- but this isn't exactly the case.

Complications

One of the first things to note about the rare earths is that most of the extraction industry in China is off limits to foreign investors. One simple reason: Many of the mines are illegal. The government is trying to clamp down, but the New York Times reported that in the past smugglers accounted for as much as one-third of rare earth exports. In addition, foreign investors are shut out of some of the main legitimate mining companies, which are available only on the highly restricted Shanghai A-share market.

Mutual Funds

Mutual funds give investors a chance to invest in a range of companies in the rare earth metals sector. These professionally managed funds are scarce, but a Swiss-based mutual fund, Dolefin Rare Earth Elements, uses the “mine-to-market” concept to get exposure to the entire value chain. The largest holding is Hitachi Metals, a Japanese company that uses a rare earth metal to produce magnets for electric motors in hybrid cars and all-electric vehicles.

ETFs

Exchange Traded Funds also offer a variety of companies, and unlike mutual funds they generally have lower expenses and can be bought and sold during the trading day instead of only after trading. Rare Earth ETFs also differ from the managed mutual funds by replicating industry indexes. Market Vectors Rare Earth/Strategic Metals ETF -- REMX -- is based on the Vectors Global Rare Earth/Strategic Metals Index. Swiss-based UBS ETF-STOXX Global Rare Earth UCITS ETF follows the STOXX Global Rare Earth Index.

The China Effect

Mutual funds and ETFs feature foreign manufacturing companies as well as Chinese mining firms. But Chinese domination of the mining sector means that China's regulation of can affect fund results by moving rare earth metal prices. For example, prices soared in 2010 when China announced it would restrict exports. But the resulting bursting of the sector's bubble helped push fund results into negative territory.