Lower-risk investments in China can still be found
By John F. Wasik Bloomberg News
TUESDAY, JULY 5, 2005
China is the great riddle of global investing. Will capitalism and growing freedoms soon transform the nation into a major league economy, or will unresolved structural woes hold it back?
The People's Republic is hard to bet against, with an economic growth rate of 9.4 percent last year and its vast population turning into active consumers.
Questions abound on the health of the Chinese banking system and stock markets, state control over myriad enterprises and political repression.
Yet there are ways of investing in the country without exposing your holdings to too much political and economic risk.
William Bernstein, a money manager who is author of "The Birth of Plenty: How the Prosperity of the Modern World Was Created," is relatively optimistic about China's track of economic reforms, although he is "not optimistic about China as a place to invest. Economic growth has almost nothing to do with stock returns."
While the difficulties of mainland Chinese stock markets have been well publicized, the weakness of the country's banking system is not fully known.
During the past five years, the Shanghai Composite index has dropped 45 percent; it was down 17 percent for the year through July 1, according to Bloomberg data. During the past 12 months, Chinese stocks have been the worst performers among the 79 indexes Bloomberg tracks.
The stock slump is hurting the government's long-range plan to sell $240 billion in state-owned enterprises.
Bernstein notes that China, like other Asian economies, is hurt by the large number of stock offerings, which tend to dilute shareholder returns.
The pool of shares is "being dramatically expanded, and that cuts into equity returns," Bernstein said. Changes are being proposed to address this dilemma as the government is considering a $15 billion bailout of the Shanghai market.
Uncertainty over whether the government will de-link the yuan from the dollar or revalue it is another factor that makes many international investors wary of China.
Nevertheless, Edmund Harriss, the London-based manager of the $110 billion Guinness Atkinson China & Hong Kong fund, sees great value in China because he is sanguine about economic renewal.
He also expects the Chinese middle class to double over the next five years to 100 million households, or about 300 million people.
In comparison, the entire European Union work force is about 223 million.
Furthermore, about 300 million Chinese are expected to move from rural areas into cities in the next 15 years, continuing one of the largest human migrations in history.
"You know where China is going and it's not going down," Harriss says. "Chinese shares are looking cheap on a cash-flow basis. China is on a long-term growth trajectory."
According to Ted Fishman, who spent 10 months visiting and researching China for his book "China, Inc.: How the Rise of the Next Superpower Challenges America and the World," China is a difficult market now for individual investors because the best companies there tend not to be listed on exchanges.
"For retail investors, China is a tough, tough place to invest now," says Fishman, "and it's only worthy for a portion of the high-risk part of your portfolio."
The worst way of investing in China is the most obvious one, because it concentrates country risk: Picking a single stock or a tightly focused sector fund that invests exclusively in mainland stocks.
An index of Chinese stocks might be more appropriate. Consider the iShares MSCI China Tracker, which is registered in Hong Kong and tracks the Morgan Stanley China index. The fund returned 19 percent over the past three years, according to Bloomberg data through July 1.
For a less risky and even broader play that includes most emerging markets, the Vanguard Emerging Markets Stock Index Fund tracks almost 600 companies, including those in China.
The fund is up 24 percent over the past three years, placing it in the top 2 percent of its peers.
A newer though similar emerging markets fund is the iShares MSCI Emerging Markets Index Fund, up 34 percent last year.
Although China will certainly produce a powerful economy in years to come, there will be huge bumps along the way. Its tiny middle class still has a lot more growth ahead of it.
The Chinese Academy of Social Sciences released a report last year suggesting that the middle class accounted for 2.8 percent of the country's population in 2004, according to the China Daily's Web site.
Other estimates say the Chinese middle class ranges from 5 percent to 13 percent of the population. The middle class is expected to make up about half of the population in 2020, the report said.
According to the academy's standard, families with assets valued from 150,000 yuan, or about $18,110, to 300,000 yuan can be classified as middle class.
Barriers to international investment will also need to be eased.
"It doesn't make a whole lot of sense to invest directly in the Shanghai or Shenzhen markets right now," says Harriss, who invests primarily through the Hong Kong stock market, which is one of the most open exchanges in the world.
At present, foreign investors are generally barred from investing in yuan-denominated "A" shares on the Shanghai and Shenzhen exchanges.
Western investors typically invest on the less-restricted Hong Kong exchange, where they can buy "H" shares in mainland companies such as PetroChina, Asia's largest oil producer.
While economic and civic freedoms will go a long way in making China a colossus in the future, now is not the time to have it represent a large part of your retirement kitty. When and how the nation will resolve its internal banking and stock-market woes remains an enigma that's best left to academics and economists, not investors, at least for the time being.
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