Markets
What's Driving the Asian Giants?
For China, it's manufacturing. For India, it's services. For you, it means profits.
By Andrew Tanzer, Senior Associate Editor
From Kiplinger's Personal Finance magazine, December 19, 2005
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Three ways to saddle the Chinese dragon
After four years of steady share-price declines, Chinese stocks appear to be reasonably valued. An index of A shares that trade on the Shanghai exchange sells for about 18 times the past 12 months' profits and 1.8 times book value, or assets minus liabilities (the comparable figures for Standard & Poor's 500-stock index are 19 and 2.9).
Still, Chinese stocks are risky, and even if you invest in mutual funds, be prepared for substantial volatility. We describe one ordinary, open-end fund and two closed-end funds.
Look before you buy. Mark Headley, co-manager of Matthews China fund, thinks it's vital to visit Chinese companies and study them carefully before investing. Headley, 46, who runs the open-end fund with Richard Gao and Paul Matthews, cites the example of a Shanghai textiles company that went public a few years ago. The prospectus for its initial public offering showed a beautifully lit new factory. But when Headley checked out the factory, he found only dark, empty warehouses. "They had doctored the pictures," he says. "It was disturbing."
Matthews invests primarily in companies that do business in China. Unlike exporters, which are constantly cutting prices, domestic firms benefit from the enormous increase in the purchasing power of Chinese consumers. Headley notes, for example, that ten years ago most visitors to Beijing's Forbidden City were foreigners. "Now, it's 90% domestic tour groups visiting sites of their own cultural heritage," he says. One of the fund's top holdings is Shangri-La Asia, a hotel company that derives most of its revenues from Chinese properties.
Over the past five years to November 1, Matthews China (symbol MCHFX; 800-789-2742) returned an annualized 14%, compared with 7% for the average of all open-end China funds. Annual expenses, at 1.43%, are far below the category average of 2.14%.
Spectacular results. State-owned enterprises leave Chris Ruffle cold. "They act in the interests of their largest shareholder: the state," says Ruffle, manager of closed-end China Fund. Ruffle, a Shanghai-based, Chinese-speaking Oxford graduate, likes companies whose managers are major shareholders, and he prefers domestic players to exporters. "China, not the U.S., is the high-growth economy," says Ruffle, 46.
Closed-end funds generally issue a fixed number of shares and then trade on exchanges just like stocks. The shares usually trade at discounts or at premiums to the value of the fund's underlying assets.
China Fund has been a stellar performer. Over the past five years, it returned an annualized 18% on assets, according to Morningstar. In mid November, the fund (CHN, $25) traded at a 4% premium to net asset value (NAV). Annual expenses are 1.41%.
Two of Ruffle's favorite themes are the drive to improve China's rural economy and the need for more infrastructure spending. "For the Communist Party to stay in power, the number-one priority of the leadership must be to reduce the income gap between residents of the countryside and city dwellers," he says.
Taiwan play The long-term record of the closed-end Taiwan Greater China fund is dismal -- it lost an annualized 5% on assets over the past five years. But the fund's returns have perked up since Steve Champion took the reins in 2004. Champion changed the fund's strategy to focus entirely on China plays -- Taiwan-listed companies that derive a large share of their revenues from the mainland. Over the past year, the fund's NAV climbed 6%, compared with a 14% slump in the MSCI China Index. At $4.85 per share, the fund (TFC) sells at an 8% discount to NAV. At 2.79%, the fund's expense ratio is well above average.
Champion, 59, makes a strong case for investing in China through Taiwanese stocks. For starters, 70,000 Taiwanese firms have invested more than $100 billion in the mainland and employ more than ten million workers. Taiwan shares a common tongue (Mandarin) and culture with China, but Taiwanese companies tend to be better managed and place a greater emphasis on profit margins. Champion's largest holding, electronics giant Hon Hai Precision Industry, is China's biggest exporter.