In The News
White-Hot China
Individual investors are flocking to China, but the journey is not without substantial risk
http://www.usnews.com
3/15/2004
By Paul J. Lim
USA TODAY
After the SARS outbreak last year, Christopher Wolfe flew to Taiwan and met with Asian executives to gauge the health of the Chinese economy. Surprisingly, the region "felt a lot like Silicon Valley in 1998," says the head of equity investments for J. P. Morgan Private Bank. Just substitute the words mainland China for World Wide Web.
"It was stunning," Wolfe says, noting that every business leader wanted only to discuss investment opportunities in China. "There was zero interest in doing business anywhere else in the world. That kind of myopia is what people fear the most--it's what usually takes place in the final stages of a bubble."
A year later, it's unclear if the frenzy for investing in China has reached bubble proportions. If it is indeed a bubble, it's also uncertain when it will pop. Still, China is beginning to resemble Silicon Valley in more ways than one. Following the stunning performance of Chinese stocks last year--the Morgan Stanley Capital International China Index soared 88 percent in 2003, outpacing even the Nasdaq--U.S. investors have developed a real yen for Chinese fare. And investment companies are scrambling to fill it.
Last year, investors poured $834 million into mutual funds that invest in Chinese, Taiwanese, and Hong Kong stocks, according to the fund tracker Lipper. While that's nothing compared with the billions plunked into Internet stocks in 1998 and 1999, it's nine times what Americans invested in the region the previous year. Meanwhile, investors have become so ravenous for a piece of the fast-growing Chinese pie--the mainland's economy is expected to grow 8.4 percent this year, twice the U.S. growth rate--that they're willing to pay steep premiums. Consider this: Each share of the China Fund, a "closed-end" mutual fund that trades on the New York Stock Exchange, has an underlying value of about $28 in Chinese stocks, according to fund tracker Morningstar. Yet last week, investors were willing to bid nearly $35 for each share. "We are in the early period of what could become a euphoria," notes Mark Headley, president of Matthews International Capital Management, which operates several mutual funds that invest in Asia, including one devoted nearly exclusively to China.
To be sure, the Chinese stock market, despite its outsize gains, is nowhere near as frothy as the Nasdaq was in late 1999, based on traditional measures such as price-earnings ratios. And some market watchers think all the "bubble" talk is overdone. But one thing cannot be denied. "There are a lot of investors coming into this market who don't understand the risks," says Headley.
Field of funds. That hasn't cooled the ardor of the financial services industry. In January, Fred Alger Management launched the China-U.S. Growth Fund, investing primarily in companies in China, Hong Kong, the United States, and elsewhere that could benefit from China's economic expansion. It joins a growing field of about a dozen traditional mutual funds, closed-end funds, and other investments that give small investors direct access to the greater China region, defined as the mainland, Hong Kong, and Taiwan.
Meanwhile, Barclays Global Investors filed with the Securities and Exchange Commission early last year to launch a new exchange-traded fund that will mirror the FTSE/Xinhua China 25 Index. Once this fund is launched, it will join Barclays's other China-region offerings, which include exchange-traded funds that track the Hong Kong and Taiwan stock markets.
Don't be surprised to see more such offerings, says Emily Hall, senior mutual fund analyst at Morningstar. Fund firms are notorious for launching new investments at market peaks. "You saw it with Internet funds, biotech funds, and even principal-protection funds in the recent bear market," she says.
For investors, China beckons for two simple reasons: Its economy is growing much faster than America's, and its stocks are producing far greater gains, on average, than shares of U.S. companies. "China is acting as the growth driver for Asia as well as for the global economy," says Edmund Harriss, manager of the Guinness Atkinson China & Hong Kong Fund. Over the past year, not only did the Chinese economy grow nearly three times as fast as U.S. gross domestic product, but industrial production in China grew more than 16 percent. Meanwhile, factory activity in the United States, Japan, and Germany was pretty much flat.
Over the past two years, funds that invest in the region have produced total returns of 24 percent, versus a 7 percent gain for the Standard & Poor's 500 index of U.S. blue-chip stocks. Chinese Internet stocks have done even better, with shares of Sohu.com, China's equivalent of Yahoo!, soaring 433 percent in 2002 and an additional 367 percent last year.
The Chinese market for initial public offerings of stock is also fueling an era of speculation. Late last year, the Chinese Internet travel site Ctrip.com saw its shares nearly double in the first day of trading. China Life, the country's biggest insurer, was also one of the most closely watched IPOs of 2003, raising $3.5 billion and setting the stage for a slew of new offerings this year.
But just because China is growing--and will continue to expand robustly over the next decade--it does not follow that its stock market will outperform. From 2000 to 2002, China's economy grew around 8 percent each year. Yet during that stretch, the average China-region mutual fund lost significant amounts of money, with drops of between 7.9 percent and 14.7 percent each year. Investors need to remember that "China is still an emerging market," says Rosanne Pane, senior mutual fund strategist with Standard & Poor's.
Among the biggest risk factors: the health of the country's banking system. While official estimates peg some 16 percent of bank loans as "nonperforming" (in or near default), "the true ratio could well be over 40 percent," says Richard Gao, comanager of the Matthews China fund. Another worry: that China will eventually be forced to revalue the yuan, which is tightly linked to the dollar. Yet no one expects a major move that could undo China's role as exporter to the world by making its well-traveled consumer products more expensive.
Flying high? Against this uncertain backdrop, there's the additional concern of valuations. While so-called H shares--shares of mainland Chinese companies listed on the Hong Kong stock exchange--were trading at a price-earnings ratio of around 7 at the end of 2002, the ratio has since jumped to around 15 times this year's projected earnings, notes Guinness Atkinson's Harriss. But others point out that is less than the S&P 500's.
For investors who aren't quite ready to plow willy-nilly into such a heated market, "there are a lot of different ways to play China," says Marat Rosenberg, managing director of The Halter USX China Index. It tracks the performance of companies that do a majority of their business in mainland China but whose shares are listed on the major U.S. exchanges. Asia-Pacific region funds that invest in countries like Japan or South Korea are a backdoor entry into China, as those economies increasingly are moving in tandem with China. Mark Edwards, comanager of the T. Rowe Price New Asia fund, notes that many Korean chemical companies are thriving because of their exports into the Chinese market. "Malaysian casino stocks are also enjoying the growth in Chinese tourism," he notes.
Ditto funds that emphasize the stocks of commodity or basic-materials companies, or energy funds whose companies stand to benefit from China's immense build-out. Demand for crude oil in China has grown 50 percent in the past three years and about 400 percent over the past decade, thanks to the explosive growth in industrial production.
To be sure, "if you really want to back up the truck and play the China story, a China fund would certainly give you pure exposure," says Edwards. But he warns that he's "just not sure now's the time to be backing up the truck."
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