China: Away Over the Wall

13 Febuary 2006

Sunday Star - Times; Wellington, New Zealand
By Tim Hunter

IF THERE is one dominant economic theme this decade, it is China's impact on the world. China's GDP growth has been in double figures year after year. It has sucked in vast quantities of resources, from oil and gas to iron and wood, and its cheap exports have been the despair of manufacturers in the developed world.

With those attractions, we should expect investors to be piling into China. And they are, but not in the way you might expect.

A big issue for foreign investors is China's listed companies are not easy to invest in. Their shares are designated "A" and "B" and only "B" shares are directly available to foreigners.

There are 54 B shares on the exchange, compared to 824 A shares. By value, trading in B shares accounted for less than 4% of turnover on the Shanghai Stock Exchange last year.

Indices for both markets fell last year in volatile trading, particularly for the B shares, though both have had a positive start this year. As one analyst has pointed out, China has generated considerable wealth, but it has so far not tended to accrue to the suppliers of capital.

Add to that the natural hazards of buying shares in such a young market - poor disclosure, poor financial reporting, poor governance - and it's no surprise the big money often seeks other ways to buy into China's remarkable growth story. Fortunately, where the big money goes, the small money can mostly go too.

Sharebroker First NZ Capital has noted increasing interest in China from its New Zealand clients. "Certainly the Chinese economy is growing at a huge rate of knots," says First NZ head of investment trusts Peter Irwin. "The issue is how do you convert that economic growth into companies that make money."

Because of the lack of information and liquidity for Chinese company shares, Irwin suggested three alternative ways to gain exposure. One was to buy commodity stocks such as Rio Tinto or BHP Billiton.

"That gives you exposure to western companies who are building profits on the growth of Chinese companies," he said.

Or you can buy into a fund that invests in commodities, such as the Merrill Lynch World Mining Trust.

This is a British investment trust managed by Merrill Lynch that has piggybacked on the resources boom with spectacular results - its most recent one-year return was 84%, the three-year was 217%.

Investment tactic No2 is to buy into countries neighbouring China that are benefiting from Chinese growth, such as Japan and Korea. For retail investors this is best done through managed funds investing in Asia.

Examples include the Edinburgh Dragon Trust, an investment trust managed by Edinburgh Fund Managers investing mainly in Singapore and Korea; and the Platinum Asia Fund, a unit trust managed by Australian fund manager Platinum, investing mainly in India and Korea.

Irwin's third option is to use specialist emerging markets fund managers such as Templeton or Fleming, who have special expertise in investing in markets where there are fewer western comforts.

One such is the JP Morgan Chinese Investment Trust, managed by JP Morgan Fleming. The fund is relatively small, just 58 million ($NZ149.8m), but it is strongly focused on China; 35% of its investments are in the People's Republic and 33% in Hong Kong.

For New Zealand investors, a locally managed option exists. Liontamer, an Auckland-based investment house, offers a range of unit trusts featuring capital protection, so investors will always get their money back even if a fund does not perform.

Last August Liontamer launched Tiger I, a fund investing in Asia with 25% focused on China. This month it is due to announce a second Tiger fund with a slightly different focus. Tiger II will be 35% invested in Japan, 20% in Hong Kong and 20% in India, with the remainder spread through Taiwan and Korea. Gaining exposure to China via proxies, as Liontamer's Tiger II is doing, is also a tactic suggested by Forsyth Barr's head of retail, Shane Edmond.

"At the moment people have an appetite to diversify away from the New Zealand retail market and take advantage of the currency," he said.

"China is one country that people are keen on, but up to now it's been difficult to get decent exposure that wasn't very volatile and risky for the New Zealand retail investor."

Where Edmond differs from other advisers is in his assessment of commodities.

"The whole resource boom in the last 12 months has been based on demand from China. But mum and dad would find it difficult to pay the BHP or Rio price today because of the risk of being sucked in at the end of the rally. Analysts are finding it difficult to justify some of those valuations at the moment."

Edmond got some corroboration for his view last week as oil, gold and copper prices sank, dragging share prices with them.

Meanwhile, Forsyth Barr is suggesting investors look at a new fund set up to track the FTSE/Xinhua 25 index - the iShares China 25 Index Fund.

The fund is designed to allow investors to buy into the performance of the largest, most liquid Chinese companies available to foreign investors. Its main investments are oil and gas, and telecoms, in the form of China Mobile, PetroChina and CNOOC. It partners the iShares A50 fund, but as a "blue chip" style fund its performance should be less volatile than the A50, which invests in China's A shares.

Performance to date has reflected the scratchy returns from China's listed firms, lagging well behind the returns available from proxy investments. That could change.

Resources stocks may have done their dash, China's sharemarkets and governance may improve, and Chinese growth is forecast to continue around 10% for some time.

Whatever method investors use, China deserves to be a part of their investment strategy.

Your investment adviser should be able to provide sensible options.

If not, get a new adviser.