Is it wise to bet on China?
Investors find country's vast potential may be worth risk
11:13 AM CST on Tuesday, December 9, 2003
By BILL DEENER / The Dallas Morning News
Think of the American Industrial Revolution, the East Texas oil boom and the Internet explosion all roiling through a country of 1.3 billion people. That is China today.
It is either an economic awakening of a magnitude perhaps unseen in human history or one heck of a speculative bubble. In any case, U.S. investors are beginning to take notice and make bets that this is the real deal.
"Many investors now believe China is one of the best investment opportunities in the world right now, said Tim Halter, managing director of the USX China Index, an index that tracks Chinese companies. "There is an economic miracle taking place there."
AP
Wen Jiabao, Premier of China (center) waves to the trading floor at the New York Stock Exchange Monday.
But prudent investors should tread carefully here, because Wall Street has been waiting for China's economy to thaw for the better part of 20 years. With so much untapped economic potential, perhaps no country has disappointed investors more than China.
Still, with relaxed government controls and a dramatic shift toward capitalism, money is beginning to flow into the country and into China-focused mutual funds and stocks at a sizzling pace.
The average monthly inflow during the first five months of this year was a paltry $11.8 million into the nearly two-dozen mutual funds that invest in China, according to Lipper. But during the last five months, average monthly inflows have increased to over $100 million, and $235 million flowed in during October alone.
Assets in these funds have increased to $1.5 billion from $582 million. Not surprisingly, mutual fund investors chase performance, and the performance of these funds has been spectacular. Many are up 50 percent and more.
"China is just an incredible story," said Mike McElwrath, chief executive officer of a small gas exploration company doing business in China. "The Chinese government has just thrown the doors open to foreign investors. It is like Houston during oil boom."
How to invest in China
But despite the "run-up there" said Mr. Halter, a lot of investors are now asking how to invest in China.
This is where it gets a little tricky.
China opened two stock exchanges in the early 1990s – in Shanghai and Shenzhen. But investors shouldn't expect their local brokers to place orders through those exchanges. These exchanges are still reserved mainly for domestic investors, not foreigners.
Further, the dollar volume on these exchanges is miniscule – less than $5 million a day – and the requirements to list on them are lax, Mr. Halter said. So for small investors, probably the best way to gain access to this country is through one of the China-focused mutual funds. Large mutual fund companies, such as Fidelity, Dreyfus and Barclays offer China-centric funds.
Fund managers typically buy stocks in Chinese companies through the Hong Kong exchange, where most of the most stable and prominent Chinese companies are listed. The Hong Kong exchange has been operating since 1891.
Richard Gao, portfolio manager of the San Francisco-based Matthews China fund, said the Hong Kong exchange has reporting and disclosure rules every bit as strict as the U.S. exchanges. He frequently visits Chinese executives in Hong Kong and the mainland to get a better understanding of the companies.
"Before I buy a Chinese company stock, I will usually visit the company's operations and talk to the analysts," Mr. Gao said.
That strategy apparently has worked. So far this year, the Matthews China fund is up 55 percent, making this the best year ever for the fund.
Another option for small investors is to buy U.S. traded shares called American depositary receipts. Typically, only the largest, most liquid shares trade as ADRs. Currently, about 40 Chinese companies trade as ADRs on U.S. exchanges, and they can be purchased through most any U.S. broker.
Shares of China Mobil, which provides cellular service, trade as ADRs under the symbol CHL. China Mobil shares are up 24 percent so far this year. The ADR shares of Beijing-based Huaneng Power International Inc. – trading symbol HNP – which operates power plants in China, are up almost 100 percent this year.
Mutual funds and ADRs are the most direct ways to invest in China, but some investors might prefer the indirect approach. They should consider buying shares of companies that don't have headquarters in China, but stand to benefit by the Chinese economic expansion.
Thriving industries
Companies in Japan, New Zealand and South Korea are among the beneficiaries, said Amit Khandwala, chief investment officer of the international investments at Wright Investors Service. For example, South Korea's Posco, the world's fourth-largest steelmaker, is one of the main suppliers of steel to China.
China plans to build 4,000 miles of roads, new skyscrapers and apartments, and that takes steel – and a lot of it – Mr. Khandwala said.
"China is now the largest importer of steel in the world and the second-largest importer of oil," he said.
Japanese companies are selling heavy machinery to China, and Taiwanese companies are selling chemicals and technology, he said. And many U.S. based companies – especially gas exploration companies – have operations in China.
Mr. McElwrath, CEO of Houston-based Far East Corp., said his company has invested about $3 million to $5 million in China for the rights to drill.
Far East now has the right to drill on 1.3 million acres of land in China, he said, and has just completed some of the first exploratory wells. Chinese government officials were very accommodative, he said, because the nation must develop its energy reserves if the economy is to keep growing.
"It was no more hassle dealing with the Chinese officials as it was dealing with the U.S. officials," Mr. McElwrath said. "And for a similar amount of acreage in the United States, we would have had to spend $30 million."
Catalysts for recovery
The seeds for China's economic turnaround were planted more than 20 years ago when the country's Communist leadership began shifting from a highly controlled, government-run economic system to a more open capitalistic system. Since then, many state-owned enterprises have been sold or closed.
In the early 1990s, state-owned companies accounted for 80 percent of China's economic output. Today that percentage has dropped to 20 percent, said Mr. Gao of the Matthews China fund.
"Officially, China doesn't call itself a capitalistic country, and they still regard themselves as socialists, but I think it is fair to say that it is a 70 percent to 80 percent market economy," he said.
The economy really began to surge in 2001 after China joined the World Trade Organization. As a WTO member, China dropped its tariffs on imported goods, enacted laws to protect copyrights and patents, and allowed its currency to float.
This represented a giant step forward because it helped lure foreign capital and companies into China.
"Joining the WTO just brought the country up to another level economically," Mr. Gao said. "It showed the world that China wanted to become a major economic player."
About $52 billion in foreign investment flowed into China last year – more than what flowed into the United States.
"That means large institutions – the smart money – from around the world poured money into China," Mr. Halter said.
Legendary investor Warren Buffett took a sizable stake in PetroChina a few months ago.
Although the investing climate looks promising, betting on an emerging market is always risky business. China might decide to revalue is currency, making its goods more expensive, and that could hurt company profits.
Further, most stocks in Chinese companies have already experienced a tremendous run-up, so there is the risk that new investors will come too late to the party.
These issues notwithstanding, most experts say the long-term prospects for China are excellent.
Marat Rosenberg, co-manager of Halter Financial Group, said it's entirely plausible that the Chinese economy cools and retreats, and that could result in some pain to investors. But at the moment it is the fastest growing economy in the world.
"They are headed in the direction of capitalism," Mr. Rosenberg said. "The genie is out of the bottle."
E-mail bdeener@dallasnews.com
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