To Leap or Not to Leap
“People are really flocking to China, given the growth,” said Jane Leung, senior portfolio manager at Barclays Global Investors. “But investing in China is not for the faint of heart.”
Her two comments neatly sum up tough choices facing average investors. The prospect of heady profits makes a plunge into China stocks almost irresistible; Chinese companies listed in Hong Kong soared 55% in 2007, underpinned by amazing annual growth of about 11% by the Chinese economy. But that faraway market is unusual, even for an emerging market. It’s scary to take the plunge when you can’t see where you’re going.
To provide some illumination, China Gate got advice from experts who understand the ins and outs of the exotic Chinese markets. Ms. Leung is one, as is David Lazenby, director and senior portfolio manager of the Emerging Markets team at Batterymarch Financial Management, which advises institutional investors.
Lazenby helped Batterymarch decide to get into the China market in 1992, barely more than a year after China launched stock markets. There were lots of uncertainties way back then. Chief among them was doubt about whether China’s communist leaders would really allow foreigners to own stakes in government enterprises. “In the beginning some said they (Chinese authorities) might take the stocks back,” Lazenby said.
That scary prospect is no longer a problem. Chinese capital markets are significantly more sophisticated now. That seems to indicate it’s a much easier decision to get into Chinese stocks today. Not necessarily, according to Lazenby.
“Some issues make entering the market tougher,” he said. “Today given the recent market rally, valuations are a little less comforting.” China was the largest overexposure in Batterymarch’s emerging markets fund in 2006, but huge gains caused the company to drop back to neutral on China for most of this year. Then despite some volatility, China stock became even more pricey. “Now for the first time in a number of years we’re underweight on China.”
But that doesn’t mean investors should shun China. “I’m often asked, ‘Is there a bubble (in China and other emerging markets), is it too late?’ Basically the answer is a resounding, ‘No.’ Currently we’re relatively underweight in China, but the long-term story is definitely attractive.”
If you decide to go ahead and invest, the next step is to pick which stock to buy.
There are a lot of different classes of stocks, and Batterymarch chooses from the complete range offered in Hong Kong and China: Chinese companies listed in Hong Kong (H shares), Hong Kong registered and listed companies set up by large Mainland enterprises (Red Chips), stocks in China open to foreigners (B shares) and Chinese stocks originally restricted to domestic investors but recently partly opened institutional investors (A shares).
Each type of stock has its plusses and minuses. (Please see the page, “Scorecard,” for a deeper look at the different stocks available.) Lazenby noted that H and B shares and Red Chips are available for average investors, but require relatively close relations with brokers that handle such shares. There also may be higher commissions and fees. It’s easier and perhaps cheaper to buy ADRs for China-related companies on major U.S. exchanges. Giant companies like PetroChina are available in ADRs for basically the same price as their shares fetch in Hong Kong. But a smaller range of companies are sold as ADRs than as H shares and Red Chips.
“On average we’re less exposed to big cap companies available as ADRs than to other names that are not so available (on U.S. markets),” Lazenby said. “We’ve done really well stocks with more exposure to domestic consumption in China.” These stocks include financial and retail companies as well as those involved in China’s plethora of infrastructure projects, such as steel producers or construction firms.
To select individual stocks Batterymarch depends mainly on sophisticated and expensive software programs, supplemented by traditional analysis. Its Asia ex-Japan fund takes voluminous statistics from some 1,500 stocks and feeds them to powerful computers to evaluate the shares on cash flow, earnings growth, expectations and technical factors. Ordinary investors can’t afford this costly process, but some of the results of the number crunching can be found. “You can go to Yahoo Finance and research some (China-related stocks) to find some of the types of analysis we look at,” Lazenby said.
He pointed out that even professionals find it difficult to time the market. It’s probably not a good idea for ordinary investors to try to buy China stocks low and sell high. “Rather than trying to pick the bottom of the market, it’s best to buy regularly over time,” Lazenby said.
Leung also underlines the difficulties that China market presents to investors not well versed in its quirks. A common recommendation is for average investors to devote 8% to 10% of their portfolio to emerging markets, including 3% to 5% in China, she said. Leung said ADR’s are a good way to buy individual stocks, but noted: “It’s probably best for ordinary investors to steer clear of individual stocks in the beginning.” Among China-related funds available are three exchange traded funds, which can by bought and sold on U.S. markets like individual stocks. Barclays operates two, iShares MSCI Hong Kong Index (NYSE: FXI ) tracks the Hong Kong companies and iShares FTSE Xinhua China 25 Index(NYSE: EWH) represents large H shares. Powershares Capital Management LLC runs the Golden Dragon Halter USX China Portfolio (Amex: PGJ) comprised of ADRs.
To sum up – Go ahead, get into China stocks. The potential rewards are hard to match. The risks are also formidable, so consider ways to minimize them such as buying regularly over time or purchasing funds.
