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A China Affair

The global selloff throughout world stock markets, triggered by the brief but sharp fall in the Shanghai Composite Index at the end of February, highlights the success of China's integration into the global economy.

China's stock markets have only just opened up to international investors. The main exchange realized a 130% gain in 2006 on a year-over-year basis, and up to the day of the selloff (February 27), the Shanghai index had gained 12% year-to-date. Then overnight, Chinese stocks plummeted by 9%.

We’ve watched as these events unfolded the past four weeks, igniting even more interest in the already hot China markets. And after a pause to reflect on what has happened, it is timely that we take a closer look at what China has to offer.

In terms of its economy, China is into its fifth straight year of double-digit growth. It grew 10.7% in 2006 and Goldman Sachs has just raised its forecast of China’s gross domestic product growth in 2007 from 9.8% to 10.8%, on the back of strong expansion in exports and money supply in the first two months of this year.

China's economy is booming and that's not even taking into account the business and tourism that will be generated by the 2008 Olympics to be held in Beijing. Moreover, China has gone through a significant reform process this decade to improve the transparency of its markets and the accountability of corporate executives. Some of the most recent reforms have been the introduction of International Accounting Standards in 2007 and the unification of corporate tax rates, which will take place in 2008.

Chinese stocks also have bounced back with the Shanghai Exchange currently trading at levels higher than before the selloff four weeks ago. Obviously, investors still think that there is value in the Chinese market. Daryl Guppy, a technical analyst and chartist at Guppytraders.com says he is much more bullish about the Shanghai market than any other market in Asia.

Guppy, using a Guppy Multiple Moving Average display, explains that markets are made up of short-term (blue lines) and long-term investors (red lines) who form the foundation of trend behavior. During the two Shanghai Index retreats in early (02/05) and then late February (02/27), while short-term investors exited the market, the long-term participants did not. Instead, as clearly seen in the above chart, long-term investors continued to buy stocks. Guppy says that this is indicative of a longer-term bullish consolidation pattern between the 2600 and 3000 levels. "The Shanghai index has no technical barriers to continued uptrend development," Guppy adds.

So, it would seem that there is still much value and money to be made in Chinese stocks. But how would you go about investing in China? It's not that straightforward. There are three kinds of Chinese stock: 'A' shares, 'B' shares and 'H' shares.

  • 'A' shares are shares in Chinese companies listed on the Shanghai and Shenzhen exchanges. Only residents of China and "qualified foreign investors" -- usually large institutional investors who have been licensed after a rigorous screening process -- can purchase them and they are denominated in yuan.
  • 'B' shares are stocks in Chinese companies denominated in foreign currencies for purchase by foreign investors; Chinese investors can buy them if they have legal foreign currency accounts.
  • 'H' shares are stocks in Chinese companies that are listed and traded on the Hong Kong Stock Exchange; H shares are the only option for an individual foreign investor to buy shares in Chinese companies.

There are pros and cons when investing in these shares. 'A' shares provide a wide range of choice when it comes to choosing companies to invest in. However, access to these shares is severely restricted. 'B' and 'H' shares are the easier to obtain, but the range of companies is limited and listings are in U.S. and Hong Kong dollars.

The fund we feature in this column gives investors the rare opportunity to put their money into Chinese 'A' Shares. That's because it's been granted a license for foreign fund direct investment in the Shanghai and Shenzhen markets.

The Fund

The AMP Capital China Growth Fund (stock code AGF) is listed on the Australian Stock Exchange. AMP Capital's strategy is to provide clients with exposure to the economic growth of China through a diversified portfolio of stocks selected directly from the mainland exchanges of Shanghai and Shenzhen. AMP identifies companies with strong competitive positions and good strategic management that have access to capital in order to grow their business.

Karma Wilson, Senior Portfolio Manager Asian Investments for AMP Capital Investors, says the advantage of investing in Chinese mainland markets is the high representation of industrial and consumer stocks. Chinese manufacturers are leveraging off their large domestic base to become competitive on a global scale. They are progressing into higher value-added industries, which provide superior returns on capital.

The move to tertiary industries means more skilled workers and higher wages. Combined with the effect of China's rapid urbanization, this provides enormous growth potential for Chinese consumer stocks.

Accordingly, AMP's top weighting sector-wise, is in consumer discretionary and staple stocks, followed by energy and financials.

China Growth Fund (as of Jan. 12, 2007)

Sector
%
Consumer discretionary 16
Consumer staples 9
Energy 5
Financials 21
Healthcare 3
Industrials 20
IMaterials 18
Telecom Services 1
Utilities 3
Others 4

The fund's top five holdings include China Merchants Bank and CITIC Securities.

AMP Capital's Top Five Holdings

Rank
Holding
% of Fund
1 China Merchants Bank 5.2
2 Zhejiang Xinan Chemical 3.9
3 China CYTS Tours 3.8
4 Suning Appliance 3.8
5 CITIC Securities 3.5
Courtesy of AMP Capital Investors

Wilson says that China's emergence as an economic power is likely to unfold over decades. Hence investors should be looking at this as a long-term holding.

The Affair

Since its listing (list price A$1.02) in September 2006, the fund has largely traded in a 12% wide band. Darryl Guppy says that investors should watch for activity signaled by a sustained breakout above or below this band.

With trends pointing to continued gains on the Shanghai Stock Exchange, Guppy adds that the fund will likely broadly follow the Shanghai index because of its direct exposure to 'A' shares. He feels that the previous high of A$1.45 is an indicative bullish target, at this point of time.

Guppy also highlights the currency advantage for China funds investing in 'A' shares. He sees the yuan moving towards a free float towards the start of 2008. Investors will enjoy a currency benefit if the yuan appreciates against the Australian dollar.

AMP Capital's Wilson encourages investors to reinvest dividends into the Chinese markets as once capital is repatriated out of China it may not be reinvested under the current Qualified Foreign Institutional Investor licensing system.

However, while the future looks rosy for this fund, there are drawbacks to investing in 'A' shares, the main one being that 'A' shares are pricier than their 'H' and/or 'B' share counterparts.

Vincent Kwan, Director and General Manager of HSI Services Limited, points out that Chinese companies that are dual listed and have both 'A' and 'H' shares, have their H shares trading at a 15% - 20% discount. The reason being that with so many Chinese investors -– hence an enormous amount of liquidity in China -– limited to domestic markets, demand has pushed stock prices up.

And that can be good or bad, depending on which side of the fence you're on. AMP Capital's China Growth Fund closed at A$1.14 on Friday.

Please send your questions and comments to us at digital@cnbcasia.com.

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