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China Hand

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As advisors seek portfolio diversification for their clients, investments in emerging markets have been receiving a great deal of attention. It can be extremely challenging for advisors to accomplish the desired level of asset, security, and geographic dispersion on their own, so emerging markets may be a case in which actively managed mutual funds, as opposed to index funds or ETFs, can add value.

With robust GDP growth rates and significant investments in infrastructure, the China region stands out, and one top-performing fund in this area is managed by Mark Mobius, portfolio manager, president, and CEO of the $151 million Templeton World China Fund (TCWAX). Mobius started the fund in 1993 as a closed-end fund, but converted it into an open-end one in 2003.

For more than 35 years, Mobius has been involved in business in Asia, and he holds a valuable credential for emerging markets investing–a Ph.D. in economics and political science from M.I.T. He literally wrote the book on emerging markets–several of them, actually.

The fund has a remarkable record as the top-performing China equity fund over the 10-year and five-year time periods, according to Standard & Poor’s, earning annualized average total returns of 9.60% for the 10 years ended December 30, 2005. The fund earned 20.85% for five years versus 9.18% for the S&P/IFCI China Index; 30.70% for three years versus 29.29% for the Index; and 17.69% for one year versus 16.76% for the Index, according to S&P, which gives the fund five-star style rankings for the one-, three-, and five-year periods, and an overall ranking of five stars.

How much money do you manage? Altogether it’s now $22 billion, including global emerging markets and area funds. For example, we have an Asia fund, we have East European, Latin American, and a BRIC fund we just started, which is Brazil, Russia, India, and China. We also have a private equity fund, what we call a strategic equity fund. I would say about 75% is global emerging markets.

And the other 25%? That includes China funds, the regional funds, East European, and that sort of thing. Actually, the Asian funds have been growing at a very fast pace, and they’re beginning to overtake some of the global funds.

Why is that area so robust right now? I think people hear about China, India, and they get excited–and for good reason–because those countries have been growing at such a fast pace. You look at China’s growth, and consistently over the last 10 years now or more, it’s been easily 6%, 7%, 8%, 9%, and India now is beginning to move up very quickly, to have 6% to 7% growth, which is very fast for these countries, when you consider [their] size.

Where is your home base now? On a plane somewhere–but I have an apartment in Singapore so I spend a little time there; Hong Kong is big for us; I would say a month to two months of the year in Hong Kong and Singapore each, and the rest traveling, really, going around the world.

You converted the China World Fund from a closed-end fund to an open-end fund a couple of years ago. Can you tell me why? We have this problem with these closed-end funds with discounts and the shareholders look at that–particularly the institutional shareholders that make a business of going after these closed-end funds with discounts because they see something going at 10%, 15%, 20% discount, and they say, “Hey, let’s close this fund, get the assets, and make ourselves that money–that difference–by liquidating the fund.” What they normally do is have a vote either to dispose of the fund or open it. That’s what happened–the Harvard [Management] people [put] a lot of pressure on the directors to do something about the discount, so we decided to convert it into an open-end fund which immediately, of course, eliminates the discount.

Has that affected the way that you are able to manage the fund at all? It really doesn’t make that much difference because the flows have not been impacted–it’s when you have small funds, and when you have big flows in and out, that you find it difficult. I would say on balance, of course, it’s always nice to have a closed-end fund because you don’t have to worry about redemptions, and new money coming in, and you can control the flows a lot better, because very often there’s a tendency for you to get more money in when the markets are at their peak, and that’s the worst time to have money [coming in]; you want to have money [coming in] at the bottom. All things being equal, I would say closed-end funds are a little easier to manage–[it] doesn’t necessarily mean that they will perform better–but our experience has been pretty good with the closed-end funds, particularly in the U.K., [where] we have an investment trust that has done very well. Looking at the China Fund, I would say there hasn’t been that much difference.

What’s your investment process for the fund? We use the same process that we do for all the other funds. We have teams of people in each of the major areas. We start with a bottom-up process, doing a very close investigation of companies. We start with a master list, then narrow it down to a smaller list, and then go into depth, going back five years into the financial history of the company. Of course, we visit the company, meet the management, and come up with documentation, which is then reviewed by a team of five people plus an industry analyst. They come to a consensus on what the buy and sell price should be, and then we enter it into our so-called action list from which the asset allocators allocate the different names on the action list.

Would you talk about your large or favorite holdings? [Mobius will not talk about individual stocks.] Banks have been important to the performance of the fund since they reflect the generally positive economic growth pictures in Asia. Recently, the technology sector has been a winner with [one company] doing particularly well as a result of their transformation from merely OEM manufacturers to developing their own brands so they can expand their profit margins. Finally, in the energy sector high oil and gas prices have pushed up prices of stocks.

We like the mobile phone business in China–in fact all around the world it’s a very good business–it’s growing fast and the numbers in China are particularly impressive. The average revenue-per-user, of course, has come down as the numbers get larger, because you’re moving down the socio-economic levels.

Would you say a little more about the mobile phone and oil sectors? They’ve been big winners for the fund and they continue to perform very nicely. The interesting thing that’s happening is with the growth ratios here in China. The earnings growth of [some of] these companies has been quite good, so that even though the market prices have moved up, the price/earnings ratios have not moved very much because the earnings have kept up with the price increases. We are still buying these companies at single-digit P/E levels, which is quite good.

Have there been any holdings that have really been disappointing? Not really; we’ve had pretty good luck across the board. There have been a few of the Taiwan tech stocks that have not performed well, but they’re now beginning to come back, so I would say, overall, that Taiwan stocks have not been winners, but that doesn’t mean that’s going to stay that way.

For the U.S. investor, where would you think that the fund would fit in their portfolio? I think the individual investor has got to start with a global fund as sort of the foundation–looking at all countries without exception–and then in a global emerging markets fund, and then going to a China fund, or an India fund, or an Asia fund. That’s probably the best strategy because China will not always be the best performer; but if you look at the long-term potential, China, of course, stacks up very high, and at this stage, China’s stocks are not that expensive. To contrast it with India, India has gotten pretty expensive, on a price-to-book or P/E ratio level, whereas Chinese stocks have not.

Why is that? In India you had these tech stocks, the software companies–you know, the call centers–and these ran up a lot; then the pharmaceutical companies did very, very well–they ran up and that created a lot of excitement in the market, then you had a lot of foreign investors coming in. There were combinations of things that resulted in a runup of that market.

So the China market still has not caught on the same way as the India market? The interesting thing about China is that the domestic market, the “A” market, has been a terrible market. It is actually the only emerging market that has gone down when all the rest went up. The reason for that is a combination of factors, because a few years ago the market ran up to very high levels, crashed down, and a lot of retail investors lost a lot of money so they’re down on the market. In addition to that, there’s an overhang of government shares because all those–mostly listed–stocks in China have a majority government ownership and the government has said, “We want to sell those shares.” So that is hanging over the domestic market. It’s a very interesting situation where, on the one hand, you have this domestic market, which ran up to very, very high levels, and came down very badly; then you have the “H” share market in Hong Kong and the Red Chips in Hong Kong, which are Chinese companies listed in Hong Kong and selling at a lower price than the mainland Chinese, the A shares. Of course, that gap has narrowed, the discount has narrowed, but still it’s quite attractive, and for that reason these markets have moved up. It’s very interesting–it’s one of the few places in the world where you can, as a foreigner, buy cheaper than the locals–that doesn’t happen very often.

Staff Editor Kate McBride can be reached at [email protected].


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