ETF Investment News & Articles
Forbes, Adviser Soapbox
Playing China From All Angles
Carlton Delfeld, 07.25.05, 4:00 PM ET
COLORADO SPRINGS, COLO. - The move by China’s central bank to drop the yuan’s rigid peg to the dollar last week on the day of a return from a three-week trip to Asia left a host of questions unanswered. The basket of currencies that will allegedly determine the value of the yuan going forward was not disclosed, nor is it clear what sort of band within which the currency will be allowed to fluctuate. Nonetheless, with $1 trillion of trade transactions each year, and hot money capital inflows equivalent to 5% of its GDP, China represents an enormous opportunity for long-term investors, although your best China investment options may not involve investing in mainland Chinese companies at all.
In the near term, the uncertainty gives investors an opportunity to benefit not just from the expected strengthening of the Chinese currency but the overall rise of Asian currencies against the dollar. In early 2005, I advised clients that the euro’s rise against the dollar was over and that Asian currencies would be the next area to appreciate versus the dollar. The cleanest direct currency play on the expected rise in the yuan (also referred to as the renminbi) is to open a renminbi currency account, which you can do online at Everbank.com.
The simplest direct equity China play is through a Chinese exchange-traded fund. The iShares FTSE/Xinhua China 25 Index Fund (nyse: FXI - news - people ) tracks 25 of the largest and most liquid China names. The annual expense ratio is only 0.74% compared to 2% or more for other alternatives out there, including actively managed Asia and greater China region funds. The China iShares provide good exposure to three key sectors of China: energy (20%), telcom (19%) and industrial (18%). This concentration can be viewed as a plus or a minus depending on your perspective. For example, some smart investors are placing a bigger bet on China’s consumer markets.
Special Offer: Profit from a contrarian perspective. A. Gary Shilling makes money for his subscribers by going against the grain—and he's usually right. He was out of tech stocks by 1999. He caught the bond rally in 2004 and in the first half of 2005, and last December, he called the dollar's rally in 2005. Click here for Shilling's major investment themes for the second half of 2005.
All of the 25 stocks included in the China iShares are listed on the Hong Kong Stock Exchange. Some of them are incorporated in mainland China (H shares) and some of them are incorporated in Hong Kong (red chips). The top five companies represent 40% of the index. Keep in mind that most of these companies are still largely controlled and owned by the Chinese government.
The total market capitalization of the FTSE/Xianhua China 25 index is $170 billion. The broadest Xinhua China index includes 1,355 listed companies with a total market cap of $550 billion. To put this in perspective, the average market capitalization for a company in the S&P Global 100 Index is $70 billion. Again, that’s for one company.
The best way to invest in China, however, may be through more indirect vehicles that benefit from Chinese growth and its currency moves. One example is the Hong Kong iShares (EWH). This ETF has sizable allocations to Hong Kong real estate (33%), utilities (17%) and banking (16%). Having just returned from Hong Kong, it seems clear that real estate markets have a way to go before becoming too pricey. Supply is inflexible, and even if prices rise as expected 30% during the next 18 months, price levels will still be about 50% below where they were in 1997. Being the last Asian currency pegged to the dollar should encourage capital inflows. Furthermore, the Hong Kong market has been much more successful than the Shanghai and Shenzhen stock exchanges in signaling that it will be China’s financial capital for the foreseeable future.
China’s move last week will also increase pressures for a number of other undervalued Asian currencies to appreciate. To compete with the China export machine, many Asian countries have resisted letting their currencies rise, but now they have a bit of room to maneuver. The Malaysian ringgit was released from its peg to the dollar last week, and it rose 0.7% the first day. While currency appreciation will somewhat dampen export growth it will also reduce upward pressure on rising energy-import costs. Analysts expect the Malaysian economy to grow 5.5% this year.
The easiest way to invest in Malaysia is through the Malaysia iShares (EWM), which track a basket of leading companies listed on its exchange. Another attraction—the annual fee for holding the Malaysia iShare is only 70 basis points.
Malaysia is oftentimes overlooked by investors, even though it has progressed quietly but remarkably from a relatively poor producer of raw materials to a bustling and broadly diversified middle-income country. Positioned along the strategically important Straits of Malacca, Malaysia should be on every investor's radar screen for the several reasons:
- It has very little external debt and healthy foreign-exchange reserves.
- Malaysia has a balanced economy with strong industrial and service sectors, important natural resources and openness to foreign investment.
- It has a parliamentary system of government with powers divided between a central government and 16 states and federal territories.
- Malaysia is well situated to benefit from growth in the region with key export and investment partners being Japan, China and the U.S.
- Natural resources include tin, petroleum, natural gas, timber, copper, iron ore, bauxite. It is also a small but consistent exporter of oil and natural gas.
- It has a young and increasingly well-educated population with a median age of 24 and a literacy rate of 90%.
- Malaysia’s per capita income is approaching $5,000, and it has a growing middle class.
Another smart indirect China play would be to invest in the Canada iShares (EWC). The Chinese are going on a buying spree investing in Canadian energy companies and recently plunked down $2 billion to build a thousand-mile pipeline from Alberta tar sands to a port on the west coast and onward to Beijing and Shanghai. The Canada iShares track the MSCI Canada Index that has 40% exposure to Canada’s energy and materials sector.
And what about Starbucks (nasdaq: SBUX - news - people ) as a China play? Starbucks has about 9,000 stores worldwide, and in the first quarter of 2005, its sales were up 27% and net income exceeded $100 million. It entered the Chinese market in 1999 and has about 300 stores that have performed beyond expectations. The company hopes to expand to 30,000 stores, and China is a key part of its expansion strategy. With 250 million Chinese approaching middle class, and millions of newly affluent status-conscious youth, Starbucks expects that before long China will be its second most-important market.
Duringa recent trip to China, I visited ten Starbucks stores, and all of them had brisk activity with a lot of young Chinese enjoying not only coffee products but the higher margin specialty drinks. Think the Chinese will always prefer tea? Japan shows that when income levels reach certain tipping points, consumer preferences change from tea to coffee. Starbucks always looks expensive but many great companies always are. Starbucks investors have made 43 times their investment since its 1992 initial public offering.
Carlton Delfeld is head of the global advisory firm Chartwell Partners and editor of the Chartwell Advisor and the Asia Investor Intelligence newsletters. He served on the executive board of the Asian Development Bank and is the author of The New Global Investor. Click here for more analysis from Delfeld, or to subscribe to The Chartwell Advisor.
|
