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Country Insight is for investors looking for a fact filled and descriptive picture of a country's people, economy, politics and investment potential.
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Thursday, May 11th, 2006
Sell China ETF, Buy Southeast Asia
Early this year, big global fund manager were underweight China but increased allocations by jumping head first into the larger, more liquid companies that are in the iShares China ETF basket (FXI). Some just bought the China ETF to save time and money.
Independent investors can profit by following the big boys but they need good intelligence. Before making allocation changes to my portfolios, I try to check data from Emerging Portfolio Fund Research (EPFR) which tracks the trading activity of 10,000 funds worldwide representing $5 trillion of assets. According to data from EPFR, global fund managers were net buyers of Chinese equities on the average of $1.5 billion a month over the last three months. Some of the investment flows to China were funded by pulling back from South Korea. During five out of the last seven months, international fund managers were net sellers of Korean equities.
The China ETF is up 26.8% so far this year but my advice is to take at least some money off the table and look to other higher quality countries that benefit from China growth. My main concern is that almost all of the companies in the China ETF are state-owned and controlled and it is hard to believe in the quality of earnings or management.
Investors need to approach the captivating China growth story with caution - a little like approaching Niagara Falls. You don't go up right up to the foot of the falls but are content to enjoy the spectacle and the spray from the side. The same goes for China. Just get nice and wet by taking a stake in Hong Kong, Taiwan and Singapore.
When the Union Jack came down in Hong Kong in 1997, the talk of the town was that Shanghai would soon eclipse Hong Kong as the center of Chinese finance. It hasn't happened. Chinese companies have had little choice but to raise capital in Hong Kong, Singapore, New York and London.
The Hong Kong iShare (EWH) also offers investors a diversified basket of companies with a tilt toward financial services and real estate. The Hong Kong ETF is up 13.1% so far this year and is riding the wave of strong economic growth, ample liquidity, and a falling US dollar. In addition, according to a Morgan Stanley report, most of the recent market surge has come from small cap stocks. Since October 2005, the larger cap stocks which make up the Hong Kong ETF are up only 7-12%. Get in now to benefit from sector rotation.
Next, take a look at the Taiwan iShare (EWT) which is up 12.9% this year. The economic integration of Taiwan into China is moving ahead at a breathtaking rate. Taiwanese companies now account for about 65% of hardware output from the mainland.
What about the political issues with mainland China? My view is that while calls for independence have at least temporarily been muted, the desire for a high degree of autonomy from China is still very strong. There may be one China but there are three systems - China, Hong Kong and Taiwan. It looks like we are headed for China and Taiwan to formally agree to a long period of Taiwanese autonomy to see if China's system evolves into a more open, transparent system with rule of law and democratic institutions. With the Beijing Olympics and a Taiwanese presidential election in 2008, investors should take advantage of the current cooling of the temperature. It is likely that China will lift its travel ban to Taiwan by the end of the year which will lead to a tourism boom.
Investors can also count on Singapore Inc. to have a forward-leaning plan plus the talent and will to execute it. Looking to spur growth and reduce its dependency on cyclical industries like electronics and manufacturing, the current plan is to make Singapore Asia's hub for life sciences and financial services.
To succeed in the competitive arena of life sciences and, in particular, biotech, a country needs five ingredients: talent and creativity, strong corporate partnerships, money, protection of intellectual property and top-notch facilities. Singapore is firing on all five cylinders.
It is difficult to become Asia's financial hub without a thriving well-regulated stock market. The Singapore Exchange Limited (SGX) went public in 2000 and is listed on its own bourse. The World Economic Forum's Global Competitiveness survey issued in 2005 included a section on regulation in securities exchanges. Among the 104 securities exchanges covered, Singapore ranked 10th. In the Asia-Pacific region, only Australia and New Zealand had a higher score than Singapore.
SGX has made steady progress in expanding and globalizing its listings. In fiscal 2005 ending in June, it added 80 new listings including its first Indian and Israeli company. More than a quarter of all listings are foreign companies of which Greater China companies account for over 70%.
While the Singapore market is up 18.3 %, it does not seem overvalued to me. According to data from Thomson Financial, the Straights Times Index trades at 16 times earnings, far from levels in 1997 when it was overextended at 24 times earnings.
Your portfolio may have gotten a nice kick from the China ETF but take some profits and diversify with the Hong Kong, Malaysia, Taiwan and Singapore ETFs.
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