This is shaping up to be a lost year for the largest exchange-traded funds targeting China. For example, since hitting a peak in late January the iShares China Large-Cap ETF (FXI) and the SPDR S&P China ETF (GXC) have slid roughly 20 percent and 15 percent, respectively, placing them in bear market territory.

Yet China ETFs that deliver a more targeted focus on specific corners of the economy are faring relatively better. The companies in their portfolios are better insulated from the headwinds roiling the Chinese economy, and they hold a nice blend of value and growth prospects.

A burgeoning trade war with the U.S. is about the last thing China needs right now. Prior moves to tighten credit are already slowing the economy, and a sharp plunge in the yuan in recent weeks is bringing added pressure.

That last factor is creating rising stress for many firms that have issued bonds denominated in dollars. “If you look at the universe of China ETFs, there’s a negative correlation between year-to-date returns and debt/equity levels,” says Nick Kalivas, senior equity product strategist at Invesco. If the Chinese economy slows sharply, then some firms with a lot of dollar-priced bond exposure may become hard-pressed to meet their debt obligations.

So when it comes to comparing various ETF portfolios, Kalivas adds that it pays to be cognizant of leverage.

While Invesco offers five different China-focused ETFs, he cites the Invesco Golden Dragon China ETF (PGJ) as an example of a fund that largely sideswipes the debt concerns. Companies in that fund, which charges a 0.70 percent expense ratio and has $267 million in assets, have an average debt/equity ratio of 0.38. Moreover, these firms “are not as economically sensitive as China’s larger firms that focus on exports or banking,” says Kalivas, adding that many of them are U.S.-listed tech firms and are perceived to have higher accounting standards.

The Golden Dragon fund has delivered an impressive 8.2 percent average return over the past 10 years, besting the broader Chinese market returns by nearly two percentage points during that time, according to Morningstar.

The sell-off in Chinese equities gained steam in early June, as the yuan began to slide at a more rapid clip. That’s partially due to the growing concern of a larger trade war between China and the U.S. As a quick recap, the U.S. government will impose a 25 percent duty on $34 billion worth of Chinese products on July 6, and China has retaliated with a 25 percent tax on U.S. goods worth the same amount.

The yuan’s slide is also due to signs that the Chinese economy may be slowing. Exports to the U.S. grew at a slower rate in June, compared to the first five months of 2018. You would think that smaller Chinese firms, which tend to have more limited global exposure, would hold greater appeal in the current environment. But companies in the Invesco China Small Cap ETF (HAO) tend to have large amounts of debt leverage, according to Kalivas. So the sliding yuan and the nation’s tighter credit have created greater risk for these firms.  

In past periods of rising economic stress the Chinese government has moved to stimulate the economy, and may be poised to do so again. A recent Bloomberg article indicates that China is going soft in its ongoing campaign to reduce financial risks due to a market slump and a slowing economy.

That, in turn, could lead to renewed confidence in the yuan, a possible catalyst for global investors to focus on Chinese equities once again, simply because they are quite inexpensive.

Brendan Ahern, chief investment officer at KraneShares Advisors LLC, notes that the 12-month forward price-to-earnings ratio on the S&P 500 stands at 17, compared to just 11 for the Shanghai Composite Index. Despite the modest slowdown in export growth, Ahern says the economy is doing fairly well, especially in areas like tech and domestic consumption. He adds that China’s non-manufacturing (i.e. services) Purchasing Manager’s Index has recently expanded at an accelerating pace.

Ahern’s firm offers a pair of ETFs that benefit from those areas of economic strength. The KraneShares CSI China Internet ETF (KWEB), which carries a 0.72 percent expense ratio, has more than 40 percent of its assets invested in top-tier tech companies such as Tencent Holdings and Alibaba Group, while also bringing exposure to China’s smaller up-and-coming tech firms. It’s up 1.7 percent this year, making it one of the few China ETFs with a positive year-to-date return. (PGJ is also in that elite group, with a year-to-date return of 1.8 percent.)

Investors may also want to consider the KraneShares Zacks New China ETF (KFYP), which sports a 0.73 percent expense ratio and has also managed to stay in the positive column this year with a return of 0.8 percent. The fund brings exposure to sectors highlighted in China's Five-Year Plan such as technology, consumer staples, consumer discretionary and health care.

Still, for many investors, the trade spat between the U.S. and China remains an overarching concern. “It’s a hard issue to quantify because we don’t really know the position of either side,” Kalivas says. “China needs trade to be healthy, and we’ll have to let this run its course.”

That’s hardly reassuring in the short-term. But for longer-term investors, the recent sell-off in many Chinese ETFs and the lower valuations that has brought could be enticing. A cooling of trade rhetoric and/or the implementation of Chinese government stimulus measures could provide the catalyst for investors to rebuild their exposure to the world’s fastest-growing large economy. For now, though, focus on the targeted ETFs that are best-insulated from the current headwinds.