Market watchers have spent many years predicting the fabulous riches to be made when the Chinese economic behemoth emerged from its Twentieth-Century torpor. China’s successful receipt of Hong Kong in 1997, its joining the WTO in 2001, and the breakneck pace of its industrial expansion in the last ten years have, indeed, erased some of the uglier memories of the communist-era self-destruction (such as the massive starvation of the 1950s and 1960s, the political instability of the 1970s, or the Tiananmen Square massacre of 1989). That China has reclaimed its historical place among the world’s largest economies is no longer in doubt. More dubious is the idea that retail investors can make easy riches by jumping on the China bandwagon.
To begin with, gaining exposure to the Chinese economy can be complicated. Stocks of Chinese companies and companies that do business in China come in a bewildering variety of share classes. Shares of companies that trade on the Shanghai or Shenzhen stock exchanges and are denominated in Renminbi, mainland China’s currency, are A shares. On the other hand, B Shares are those that trade on the Shanghai exchange in U.S. dollars and on the Shenzhen board in Hong Kong dollars. Meanwhile, companies that are incorporated in mainland China but trade on the Hong Kong stock exchange trade in H shares, while shares of companies listed in Hong Kong, incorporated outside of mainland China, but operating in China, are called Red Chips. Both H shares and Red Chips usually represent companies either completely or substantially owned by the Chinese government or government entities. On the other hand, Chinese companies incorporated outside of China and owned by private individuals trade in P Shares in Hong Kong and S Shares in Singapore. Finally, shares of government and privately controlled Chinese companies that trade on one of the New York exchanges are sometimes called N Shares, and on the London Stock Exchange, L Shares.
What’s more, these share classes are not equally open to all, creating occasional broad price discrepancies between classes of shares of the same company. For example, most foreigners may not buy A shares directly, and mainland Chinese are not allowed to invest in H shares. Because of its considerable personal savings rate, underdeveloped banking system, and a lack of other choices for investing, mainland Chinese pour money into the stock market, pumping up the value of A shares, sometimes far above that of the same company’s H share counterpart.
The share class issue can be confusing, but is straightforward compared to the problem of trying to evaluate what effect the actions of the Chinese government will have on the performance of individual companies. A great many of the companies that investors might consider stock in to gain exposure to China, such as China Mobile (CHL), Sinopec (SHI), CNOOC (CEO), China Life Insurance (LFC), among others, are state-controlled enterprises. As we have written elsewhere, being controlled indirectly by the government of China has potential benefits and drawbacks for companies, and by extension, for investors in those companies.
Investing in state-controlled companies and even privately controlled enterprises in China requires buyers of stock to do a lot of homework. Even then, there is substantial risk in investing in only one or two companies. A better choice for investors who want some exposure to China, with the least risk and without having to do a lot of research into individual companies, is to buy a China- or Asia-focused fund, such as the Matthews China Fund (MCHFX) and Martin Currie’s China Fund, Inc. (CHN). The Matthews family of funds has an array of Asia-oriented fund options besides its basic China Fund, such as the Matthews China Dividend Fund (MCDFX), and the more diversified (i.e. not limited to China) Matthews Asian Growth and Income Fund (MACSX) or Matthews Asia Small Companies Fund (MSMLX). Other solidly performing China funds include: Guinness Atkinson China & Hong Kong (ICHKX), Dreyfus Greater China A (DPCAX), ProFunds UltraChina (UGPIX), AIM China A (AACFX), and Direxion Monthly China Bull 2X (DXHLX).
Well-established, diversified funds targeting China are still likely the best way for retail investors to get exposure to China without taking on too much risk. Fund managers are well-apprised of current issues in their markets. For example, the possibility of a Chinese banking bubble, which we write about here, likely explains why so many China-oriented funds have underweighted their holdings in financial companies.
Even when taking this relatively conservative route, investors ought to keep an eye on China’s macro-economic and political situations. It is not always easy to see asset bubbles in an economy as non-transparent as China’s, and even the most astute fund managers may not be able to anticipate the effect on their investments of major domestic unrest, or regional instability.