Purpose: Unlock opportunities for smart investors
China’s central bank’s effort to reduce the yuan’s tight peg to the dollar on the day of my return after a three-week trip to Asia left many questions unanswered. The basket of currencies that is supposed to determine the value of the yuan in the future is not disclosed. It is unclear in what range the currency will fluctuate. A revaluation of the currency by 2% on Thursday followed by a slight gain on Friday could actually spur further short-term speculation, as most economists believe the yuan is undervalued by about 10-20%. With $ 1 trillion in trade each year and an inflow of hot money equivalent to 5% of its GDP, uncertainty about the Chinese currency is high.
Not on the mainland
In the short term, this uncertainty gives investors the opportunity to benefit not only from the expected strengthening of the Chinese currency, but also from the overall growth of Asian currencies against the dollar. In early 2005, I informed clients that the growth of the euro against the dollar was over and that Asian currencies would be the next area where the exchange rate against the dollar could be raised. It may turn out that many of your best investment options in China do not involve investing in mainland China companies at all.
Direct currency approach
The purest direct currency game with the expected growth of the yuan (also referred to as the yuan) – is to open an account in yuan currency with Everbank. A leading online bank that has been recognized by Forbes as “Best of the Internet,” Everbank offers a variety of world currency accounts, as well as CDs for three and six months supported by the FDIC that offer attractive rates.
Direct iShare approach
Another direct action in China is through China iShare (FXI), which tracks the FTSE / Xianhua China 25 index, which consists of China’s 25 largest and most liquid names. FTSE is a British index company and Xianhua is a Chinese media company.
All 25 stocks listed in China iShare are listed on the Hong Kong Stock Exchange. Some are registered in mainland China (share H) and some are registered in Hong Kong (red chips). The total market capitalization of the index is $ 170 billion. China’s broadest Xinhua index includes 1,355 companies with a total market capitalization of $ 550 billion.
To put this into perspective, the company’s average market capitalization in the S&P Global 100 index is $ 70 billion. Again, this is for one company. China iShare provides a good impact on China’s three key sectors: energy (20%), communications (19%) and industry (18%). This concentration can be considered as a plus or a minus depending on your point of view. For example, some smart investors are betting more on China’s consumer markets. The top five companies make up 40% of the index. China iShare’s annual operating costs are only 0.74% compared to 2% plus for other alternatives, including actively managed funds from Asia and large Chinese funds. Keep in mind that most of these companies are still largely controlled and owned by the Chinese government.
The best way to invest in China may be more indirect funds that will benefit from China’s growth and its currency movements. One example of indirect investment in China is Hong Kong iShare (EWH). It has significant appropriations for Hong Kong real estate (33%), utilities (17%) and banking (16%). Just returning from a trip to Hong Kong, it seems clear to me that real estate markets need to go a long way before becoming too expensive. The supply is inflexible, and even if prices are expected to rise by 30% over the next 18 months, the price level will still be about 50% lower than in 1997. Being the last Asian currency pegged to the dollar, capital inflows should be stimulated. In addition, the Hong Kong market has been much more successful than the Shanghai and Shenzhen stock exchanges, signaling that it will become China’s financial capital in the foreseeable future.
Indirect currency game
China’s actions last week will also increase pressure on a number of other undervalued Asian currencies to boost the exchange rate. To compete with the Chinese export machine, many Asian countries have resisted the growth of their currencies, but now they have room to maneuver. The Malaysian ringgit was released from pegging to the dollar last week and rose 0.7% on the first day. While an appreciation of the exchange rate somewhat slows export growth, it will also reduce the cost of rising energy imports, and analysts expect the economy to grow 5.5% this year. The easiest way to invest in Malaysia is Malaysian iShare (EWM), which tracks a basket of leading companies listed on its stock exchange. Another attraction – the annual fee for Malaysian iShare is only 70 basis points.
A performance for the informed
Malaysia is often overlooked by investors, despite the fact that it has quietly but surprisingly moved from a relatively poor producer of raw materials to a vibrant and widely diversified middle-income country.
Malaysia, located along the strategically important Straits of Malacca, should be on the radar screen of every investor for the following reasons:
It has a small external debt and healthy foreign exchange reserves. It is slightly larger in area than New Mexico.
Another smart indirect game of China is investing in Canadian iShare (EWC). The Chinese are going to buy by investing in Canadian energy companies, and recently cut $ 2 billion to build a thousand-mile pipeline from Alberta’s resin to a West Coast port and further to Beijing and Shanghai. Canadian iShare tracks the MSCI Canada index, which has a 40% impact on Canada’s energy and material sectors.
What about Starbucks (SBUX) as a Chinese play? Starbucks has about 9,000 stores worldwide, and in the first quarter of 2005, its sales grew 27% and revenue exceeded $ 100 million. It entered the Chinese market in 1999 and has about 300 stores that exceed 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 the middle class and millions of newly wealthy young people aware of their status, Starbucks expects that China will soon become the second largest market. During my recent trip to China, I visited ten Starbucks stores, and all of them were active, and many young Chinese enjoyed not only coffee products but also specialty beverages with higher incomes. Do you think the Chinese will always prefer tea? Japan shows that when income levels reach certain turning points, consumer preferences change from tea to coffee. Starbucks always looks expensive, but many great companies are always like that. Investors Starbucks did 43 times more than investing in its 1992 IPO, and revenue rose 27% in July.
China offers huge opportunities for long-term investors, but an indirect approach may be the most sensible strategy.
Next week: find out what the next big Asian bull market will be in the 21st century – a hint: “This is not China!
Karl Delfeld is the head of the global consulting firm Chartwell Partners and the editor of the newsletters Chartwell Advisor and Asia Investor Intelligence. He was a member of the Executive Board of the Asian Development Bank and is the author of The New Global Investor (iUniverse: 2005). For more information, visit http://www.chartwelladvisor.com or call 877-221-1496