Greater China investors have much to celebrate. Despite the recent turmoil in financial markets, stocks in China and Hong Kong are still booking double- and triple-digit gains year-to-date.
This (happily!) is very much contrary to Alan Greenspan’s prediction in May that Chinese markets will undergo a “dramatic correction”. So why do investors continue to flock towards mainland-related stocks?
The main attraction is China’s red-hot economy. In 2006, gross domestic product (GDP) growth hit an 11-year high of 10.7%. Recently, the World Bank upgraded its 2007 GDP forecast for China to 11.3%, citing continued strong external trade and an investment-driven recovery in domestic demand. Its massive trade surplus is adding to domestic liquidity and contributing to asset price increases, especially in shares.
Plus, with a population of more than 1.3 billion people, China offers domestic and foreign companies a massive market for their products and services.
It’s no wonder that one fund manager likened growth in China as hot as Chinese steamed buns. Voila! The China Mantou Fund.
The China Mantou Fund, launched in 2002, is a long and short hedge fund -- it holds shares that it expects will give long- and short-term returns. The fund is geared towards institutional investors.
The fund has positions in a diversified portfolio of Greater China-related equities – i.e. listed companies globally that have a majority of revenue, profits, and/or operations in Greater China.
According to Andy Mantel, MD, Pacific Sun Investment Management and portfolio manager of the fund, many Chinese stocks have low valuations relative to future growth, and the quality of corporate earnings is improving.
The China Mantou Fund takes advantage of these factors and therefore buys into the country’s blossoming private sector. It invests in small but well-managed companies that have at least an annual earnings growth rate of 25% as well as 3% dividend yield.
That strategy has paid off. Since its inception, the fund’s value has gained more than 148%, and boasts an annual return of 24.4%.
“(Our) focus is on high growth, mid-cap new economy stocks not targeted by other China funds. The fund represents a unique opportunity to capitalize on other opportunistic plays such as corporate restructurings,” Mantel said.
The fund does not limit itself to the A & H share markets – which account for only about 30% of all companies in the Greater China universe.
In fact, the majority of its holdings are parked in Chinese companies listed overseas, e.g. Hong Kong, Taiwan and Singapore. That allows it to play with more than 5,000 greater China-related stocks, giving it a relatively diversified portfolio.
“The Fund’s ability to choose from all greater China-related stocks globally is central to our investment strategy. Rather than only look at A shares or H shares, we consider the whole universe of stocks and own proprietary stock screening model helps us achieve our results,” said assistant fund manager Adam Tam.
In terms of sector picks: Internet, telecom, IT, service and transport sectors are the most dynamic, said Mantel.
He added, ‘Within these sectors and others are several companies that have exciting long term potential for exceptional returns.’
In fact, two of the fund’s largest holdings, food and beverage producer China Green and the world’s second largest container manufacturer Singamas Containers recently booked better-than-expected earnings.
But with every return there is a risk.
According to Philip Chan, Director at Shenyin Wanguo Securities, while there is value to be found in mid-cap stocks, it is still safer to invest in the blue chips.
“These are private enterprises; therefore you need to look closely at management quality. If you have to be in Asia, you need to buy the blue chips. They are highly valued, but at least there is cushion during bad times because these are supposed to be quality companies,” said Chan.
Meanwhile China’s booming economy has proved to be a double-edged sword. The government has intervened in recent months to prevent the economy from overheating. Flashback to September 14th when the central bank raised rates for the fifth time this year.
Some analysts say the stock market is fairly overheated - which could prompt Beijing to take further action to cool it. In fact, in the first five months of the year, more than 20 million brokerage accounts were opened – that’s four times the number opened in all of 2006. Moreover, the stock market is valued at more than 40 times earnings – nearly three times the price to earnings ratio of the S&P 500.
One of the reasons for this high valuation is the domestic investment environment. Chinese nationals have few options in terms of where they can invest their money because of government restrictions. Chinese citizens are currently only permitted to invest in “A” shares – i.e. shares in Chinese companies listed on the Shanghai and Shenzhen exchanges.
But just this past August, Beijing announced it would allow individual investors to buy and sell Hong Kong-listed stocks through individual share trading accounts operated by mainland branches of the Bank of China. This sent the Hang Seng Index soaring.
Responding to the threat of monetary tightening in China, Mantel says he is shorting Chinese banks.
He writes in the The Gloom, Boom & Doom Report, “Lending will slow this year and next, due to Beijing’s efforts to slow the juggernaut economy to a more acceptable growth level, and also due to the government’s clampdown on bank loans that have made their way into the stock markets.”
Meanwhile, stellar corporate profits enjoyed by Chinese companies may not go on forever. In a recent report by Standard & Poor’s, revenue and profit is likely to slow down over the next 18 months.
Ryan Tsang, a credit analyst at S&P said that so far, China has overcome obstacles like high oil prices, and liquidity and credit crunches – but will not do so for long.
“The markets could be lulled into underestimating and under-pricing risks during long periods of strong growth and high earnings. While we expect growth to remain healthy, we're aware of the challenges ahead for Chinese companies,” Tsang said.
According to S&P, these challenges include negative real interest rates, inflation, strong credit expansion, and the risk of a slowdown in the U.S. Quality issues about Made-in-China products are also expected to hit some exporters.
But as I write this, Chinese stocks have hit yet another record high – defying news of an interest rate hike and an imminent policy meeting by the U.S. Federal Reserve. Such buoyancy is indeed a characteristic that has caught the attention of many investors.
“Asia and China in particular have been drawing interest for the last two weeks, with investors apparently impressed by the resilience of the Shanghai stock market,” BZ WBK brokerage said in its September 7 report on emerging markets fund flows.
So it looks like the hype about all things China will continue to be as hot as those Chinese steamed buns. And by chance, if you’re wondering exactly what mantou is …
Mantouis a steamed bun originating from China. It is typically eaten as a staple in many parts of the country and is made with milled wheat flour, water and leavening agents. In size and texture, they range from small, soft and fluffy in the most elegant restaurants, to large, firm and dense for the working man's lunch. Legend has it that these buns were created during the Three Kingdoms period. According to accounts, Chu Keliang, the advisor to the Kingdom of Shu, saw that natives were using people's skulls as a sacrificial tribute to the Emperor. He convinced them to use 'heads' made from flour instead. He was successful, and then soon their popularity grew widespread throughout China.
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