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China’s stock market may be due for a rebound but risks are high

by Wayne Cheveldayoff, 2005-11-24

One argument for investing in Chinese stocks at the present time is that since they have done so poorly in the past year, they must be due for a rebound.

Another is the country’s real economic growth rate of 9 per cent, which is a very rapid rate that has persisted for some years.

Still another is the expectation that China’s currency will be revalued upward at some point in time to reflect its outstanding success as an exporter. An upward revaluation would raise the value of Chinese company shares in Canadian dollar terms.

With its booming economy, China should be a good place to invest. Rapid growth creates profits for companies and the Chinese stock market should be booming along with the Chinese economy.

But it hasn’t been that way recently. Despite rapid economic expansion for many years and the likelihood that it will continue, China’s stock market has drifted lower for close to a year.

This is reflected in the valuation of China mutual funds that are offered in Canada. Some are down almost 10 per cent in the three months ended October 31, according to GlobeFund statistics.

Excel China Fund, for example, is down 9.4 per cent in the three months ended October 31 and down 10.4 per cent overall in the past year.

Talvest China Plus Fund is down 9.9 per cent over three months and is up only 1.1 per cent over a year.

The AGF China Focus Class Fund has dropped 10.6 per cent in the most recent three months, although it is up a decent 6.7 per cent from October 2004.

Choosing investments is all about judging risk versus potential reward and in the case of investing in China, the risks are plentiful.

One of the reasons cited by experts for the recent decline in Chinese stocks is that the Chinese government is in the process of selling off state-owned companies, which is flooding the market with shares. The market remains at risk to further downward pressure from this source since the sell-off is far from over.

There is also uncertainty with respect to Chinese accounting and whether investors are getting a true picture of company performance, especially in the case of partially state-owned firms.
Another risk in China’s partial-Communist, partial capitalist system is that companies may not always be acting in shareholders’ interests. The Communist Party has considerable influence over any enterprise operating within China’s borders.

Other potential risks are disruptive civil unrest against a totalitarian regime and a vulnerability to damaging bird flu and even pandemic if the flu starts to spread through human-to-human contact.

For anyone in Canada interested in taking on the risks in order to gain from China’s economic success, the best route is to invest in a China-oriented equity mutual fund. It leaves the decisions on equity selection to a manager specializing in China for an approximate 3-per-cent annual management expense ratio (MER).

However, these are not necessarily pure-China funds. Most of those labeled as China funds invest not only in mainland Chinese companies but also those domiciled in Hong Kong and Taiwan and even those in North America or elsewhere that stand to benefit from doing business with China.

A couple of less-expensive alternatives are the China-specific exchange traded funds (ETFs) listed in the United States.

The largest of the two is the iShares FTSE/Xinhua China 25 Fund, which trades under the symbol FXI and seeks to replicate the performance of the FTSE/Xinhua HK China 25 Index, including 25 of the largest companies in China. The US $1.2 billion fund (MER 0.74 per cent) includes China Mobile, PetroChina, China Telecom and China Life Insurance, among others. Its recent price was $60.74, with a 52-week high of $65.90 and a 52-week low of $51.80.

The smaller ETF is known as PowerShares Golden Dragon Halter USX China Portfolio, a US $66 million fund with an MER of 0.70 per cent, traded under the symbol PGJ. This fund is designed to replicate the performance of the USX China Index. The fund’s recent price was $13.82, with a 52-week high of $15.03 and a 52-week low of $12.53.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2005 Wayne Cheveldayoff