CHINA - A MIXED BAG OF INFORMATION
February 2005
You take notice when Warren Buffet goes against his investment philosophies and buys a 13% stake in a state controlled Chinese oil company. Berkshire Hathaway is not the only company to take the plunge into China. Over 220,000 foreign companies have opened joint venture companies in China since 1980. Furthermore, with China’s entrance into the World Trade Organization in 2001, foreign companies were able to open Chinese operations without a joint venture partner.
China’s economy is the third largest in the world, after the United States and Japan. The Chinese economy has grown at an average rate of 7% over the previous five years and at 9% for 2004. The Chinese comprise over 20% of the world’s population, a significant supply of cheap labor. It is projected that China will be the largest economy in the world in 40 years and people are describing the 21st century as the century of China.
There are now a number of ways to invest directly in China:
· through mutual funds that invest directly in Chinese companies,
· by making an investment in a variety of exchange traded funds that hold stock in Chinese companies that are traded on the NYSE and have agreed to rules of corporate governance, and
· by investing directly in the two Chinese stock exchanges in Shanghai and Shenzhen.
The performance of equity investments in China has been impressive with returns as high as 100% in 2004. Returns have been buoyed with the decline in the US dollar. A number of brokerage houses have asserted that everyone should own a piece of China as a long-term investment. How can anyone argue with that logic?
Answer: experience. Isn’t this the type of story that propelled significant investment in Russia, with resulting significant returns for a period of time and then a precipitous 88% drop to the floor in 1998? This is the beauty of numbers: three straight years of 100% returns followed by one year with a 90% drop and you barely get your original investment back. The Russian stock market has experienced significant returns since 1998 only to watch the Russian government nationalize significant Russian companies.
The Chinese economy has a number of structural issues that we should not ignore, including:
· a currency that does not float,
· no software piracy laws, and
· a political system dominated by one party.
Multinational companies certainly cannot ignore the Chinese economy, but individual investors should stay away. Individual investments in developing countries generally should be made through a mutual fund or an investment advisor who invests in countries with proven economic systems.
In the meantime, individual investors can participate in a renewal of the Chinese economy via investments in US companies that sell their products in China.