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Investors Find Bigger Returns, Risks in China

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Nov. 20, 2003 — Mutual funds that invest a significant portion of their assets in Mainland China have racked up impressive gains this year, partly reflecting the booming economy of the world’s most populous nation. According to data from FundAdvisor, the average mutual fund with significant stakes in China or Hong Kong soundly beat the developed markets as represented by the MSCI EAFE Index, as well as the S&P/IFCI Asia Index.

However, the risks of investing in China are higher than in the developed world, as reflected by the higher volatility of Chinese-themed funds. “China Funds have provided impressive returns this year once the SARS outbreak was brought under control,” noted Rosanne Pane, chief mutual fund strategist for Standard & Poor’s. “However, investing in any emerging market does involve extra volatility due to political, economic and market risks.”

Stephen Ho, senior vice president at Hansberger Global Investors, notes that China’s economy has been one of the fastest growing in the world, with an average growth rate of 7.1% for the past six years. “Unlike previous periods, China has embarked on a sustainable growth pattern due to being the ‘factory to the world,’ as well as a growing consumer. China may be one of the world’s biggest growth stories for decades.”

Guang Yang, portfolio manager of the Templeton Global Opportunities Trust/A (TEGOX), a $361-million portfolio with close to 8% invested in Hong Kong or China, views Chinese equities as a “value play” in an economy enjoying superb growth. “China ‘s GDP will grow 8% this year, and probably 9% next year,” he said. “Sectors like auto and software are seeing their sales jump by as much as 30% to 40% annually, but most Chinese stocks are trading at moderate multiples. For example, China’s national oil company, PetroChina (PTR), which Warren Buffet purchased a stake in, is trading at only 7.6 times projected earnings for 2003. The stock has doubled in price over the past year. Another major oil company, CNOOC Ltd. (CEO), has nearly tripled in price since being privatized in 2001.”

To illustrate how China’s export economy has grown, consider that in 1990 less than 3% of products imported into the U.S. came from China, versus 18% from Japan. But by 2002, China accounted for 11% of all U.S. imports, having overtaken Japan, which accounted for only 10%.

However, despite China’s explosive growth, investors looking to participate should exercise caution. For one thing, China is still a relatively small and illiquid emerging market, which means it can undergo extreme volatility. To futher complicate the situation, it remains difficult for foreigners to invest directly in Mainland shares. Typically, one either has to put money into the Hong Kong market, or otherwise negotiate the arcane rules that govern Chinese equity markets.

As a result, there are no “pure” Mainland China mutual funds. Instead, portfolios with exposure to China usually include investments in more established, neighboring Asian economies like South Korea, Hong Kong and Taiwan. For example, one of the most well-known China portfolios, the $141.9-million Matthews China Fund (MCHFX), has the bulk of its assets invested in stocks listed on the Hong Kong exchange.

Another risk with China lies in the fact that most companies there are still primarily owned by the state, resulting in a mismatch between the interests of management and shareholders. But this situation is gradually changing, according to Yang. “The private sector is increasingly participating in the market and boosting their stakes in public companies,” he said. “In fact, China’s central government has pledged to fully privatize the economy.”

While Chinese corporations have a long way to go before they adopt Western-style corporate accounting principles, “standards are rapidly improving, particularly with the larger, established companies,” Yang added. “China’s membership in the World Trade Organization will accelerate this process.”

According to China’s vice minister of commerce Wei Jianguo, the country’s foreign trade volume is likely to reach $800 billion this year; and that from January to September this year, China’s contracted foreign direct investment reached $79.2 billion, a yearly rise of 36%.

Yang points out that Chinese officials are also now easing restrictions on equity ownership by foreigners. “The A shares, which had been exclusively limited to Chinese investors, are now available to qualified foreign institutional investors,” he said. “Up until now, foreigners could only buy the B shares, which are quoted in dollars.” However, Yang cautioned that the best way for foreigners to buy Chinese stocks is still by investing in the “H” shares of the Hong Kong stock exchange, where the largest, most stable Chinese companies trade.

The popular conception is that China is dominated by “old economy” industries like steel, oil, petrochemicals and electric power. While these types of firms do indeed represent the country’s leading corporations, technology and telecom are also booming. For example, Yang cited that Chinese cellphone handset makers now control 50% of the domestic market share, compared with just a 10% market share in 1999. Leading Chinese tech companies include telecom firms China Unicom Ltd. (CHU) and China Mobile (Hong Kong) Ltd. (CHL), and computer manufacturer Legend Group Ltd.

The following table shows mutual funds which have at least a 25% stake in either Hong Kong or China. The performance and attributes of these China-themed funds are compared to the MSCI EAFE Index and the S&P/IFCI Asia Index in the second table. As the data shows, the China funds soundly beat both indices in terms of performance. However, the average standard deviation of the funds was somewhat higher than that of the EAFE Index, illustrating the higher volatility of China region stocks, versus more developed markets.

Standard & Poor’s Pane points out that over the past five years, the average volatility for China funds was 26.8%, or 64% above the volatility of developed international markets. (The MSCI EAFE Index five-year volatility was 16.3%). Investments in China funds or other emerging markets should total no more than 5% in aggressive growth portfolios, she recommends.

Fund NameCountry Allocation One-Year Return (%)Three-Year Standard Deviation (%)Five-Year Standard Deviation (%)

  • AllianceBernstein Greater China 97/A (GCHAX) 74.7% (Hong Kong)+69.422.828.9
  • Columbia Newport Asia Pacific Fund/A (NWAPX) 41.9% (Hong Kong)+23.717.322.6
  • Columbia Newport Greater China Fund/A (NGCAX) 25.8% (China); 52.3% (Hong Kong)+48.520.224.9
  • Columbia Newport Tiger Fund/A (CNTAX) 27.7% (Hong Kong)+37.621.824.4
  • Dreyfus Premier Greater China Fund/A (DPCAX) 37.9% (Hong Kong); 27.8% (China)+57.320.830.2
  • Eaton Vance Greater China Growth/A (EVCGX) 68.8% (Hong Kong)+43.621.425.8
  • Fidelity China Region (FHKCX) 59.8% (Hong Kong)+37.920.324.6
  • Guinness Atkinson Asia Focus (IASMX) 28.1% (Hong Kong)+45.025.727.1
  • Guinness Atkinson China & Hong Kong (ICHKX) 77.5% (Hong Kong)+51.822.925.5
  • ICON Asia Region (ICARX) 26.8% (Hong Kong)+41.615.418.1
  • Matthews Asian Growth and Income Fund (MACSX) 33.7% (Hong Kong)+29.810.712.5
  • Matthews China Fund (MCHFX) 39.42% (China); 46.2% (Hong Kong)+61.321.531.1
  • Morgan Stanley Instl:Asian Real Estate/B (IARBX) 37.2% (Hong Kong)+34.518.921.8
  • TCW Galileo Asia Pacific Equity Fund/I (TGAPX) 25.5% (Hong Kong)+34.924.027.7
  • US Global Investors Fds:China Region Opport (USCOX) 33.2% (Hong Kong)+63.220.726.2

One-Year Return (%)Average Three-Year Standard Deviation (%)Average Five-Year Standard Deviation (%)

China Funds+45.320.326.8

MSCI EAFE Index+24.017.516.3

S&P/IFCI Asia Index+42.827.629.4

Source: Standard & Poor’s. Total returns include reinvested dividends. Data as of Oct. 31, 2003.


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