Objective: Expose opportunities for smart investors
The decision by China’s central bank to remove the yuan’s hard peg to the dollar on the day of my return from a three-week trip to Asia left a number of unanswered questions. The basket of currencies that is supposed to determine the value of the yuan in the future was not disclosed. It is not entirely clear in what kind of band the currency will be allowed to fluctuate. The 2% revaluation of the currency on Thursday, followed by a slight strengthening on Friday of the week, may actually encourage more speculation in the short term, since most economists believe that the yuan is undervalued between 10% and 20%. With $1 trillion of business transactions every year and speculative capital inflows equal to 5% of its GDP, uncertainty regarding the Chinese currency is high.
not on the mainland
In the short term, this uncertainty provides investors with an opportunity to benefit not only from the expected strengthening of the Chinese currency, but also from the general rise of Asian currencies against the dollar. In early 2005, I warned clients that the euro’s rise against the dollar was over and that Asian currencies would be the next area to appreciate against the dollar. It may turn out that many of your best China investment options don’t involve investing in mainland Chinese companies at all.
Direct Currency Approach
The cleanest direct forex play on the expected rise of the yuan (also known as the renminbi) is to open a renminbi currency account at Everbank. Everbank, a leading online bank ranked “Best of the Web” by Forbes, offers a variety of global currency accounts, as well as three- and six-month FDIC-backed CDs that offer attractive rates.
iShare Direct Approach
Another direct capital play from China is through China iShare (FXI) which tracks the FTSE/Xianhua China 25 Index which is made up of 25 of the biggest and most liquid Chinese names. FTSE is a UK-based index company and Xianhua is a China-based media company.
The 25 stocks included in China iShare are listed on the Hong Kong Stock Exchange. Some of them are incorporated in mainland China (H shares) and some of them are incorporated in Hong Kong (red chips). The total market capitalization of the index is $170 billion. Xinhua China’s broader index includes 1,355 listed companies with a total market capitalization of $550 billion.
To put this in perspective, the average market capitalization of a company in the S&P Global 100 index is $70 billion. Again, that’s for a company. China iShare provides good exposure to three key Chinese sectors: energy (20%), telecommunications (19%) and industrials (18%). This concentration can be seen as a plus or a minus depending on your perspective. For example, some savvy investors are betting more on China’s consumer markets. The top five companies represent 40% of the index. China iShare’s annual operating expenses are just 0.74% compared to 2% more for other alternatives, including actively managed funds in Asia and the China region. Note that most of these companies are still largely controlled and owned by the Chinese government.
indirect approach
The best way to invest in China may be through more indirect vehicles that benefit from Chinese growth and currency movements. An example of an indirect investment in China is through Hong Kong iShare (EWH). It has sizeable allocations to Hong Kong real estate (33%), utilities (17%) and banking (16%). Having just returned from a trip to Hong Kong, it seems clear to me that real estate markets have a long way to go before they become too expensive. Supply is inflexible and even if prices rise 30% as expected over the next 18 months, price levels will still be 50% lower than they were in 1997. Being the last Asian currency pegged to the dollar should encourage the entry of capitals. Furthermore, the Hong Kong market has been much more successful than the Shanghai and Shenzhen stock exchanges, indicating that it will be the financial capital of China for the foreseeable future.
Indirect game of currencies
China’s move last week will also increase pressures for other undervalued Asian currencies to appreciate. To compete with China’s export machine, many Asian countries have been reluctant to let their currencies rise, but now have a bit of wiggle room. The Malaysian ringgit broke free of its dollar peg last week and rose 0.7% on the first day. While the currency appreciation will dampen export growth somewhat, it will also reduce the cost of rising energy import costs and analysts expect the economy to grow 5.5% this year. The easiest way to invest in Malaysia is through Malaysia iShare (EWM), which tracks a basket of leading listed companies. Another draw: the annual fee for Malaysia’s iShare is just 70 basis points.
The game for the informed
Investors often overlook Malaysia even though it has quietly but remarkably progressed from a relatively poor commodity producer to a bustling and widely diversified middle-income country.
Located along the strategically important Strait of Malacca, Malaysia should be on every investor’s radar screen for the following reasons:
It has little foreign debt and healthy foreign exchange reserves. In area, it is slightly larger than New Mexico.
Canada?
Another smart roundabout move by China would be to invest in Canada iShare (EWC). The Chinese are investing in a buying spree in Canadian energy companies and recently spent $2 billion to build a thousand-mile pipeline from Alberta’s oil sands to port on the West Coast and on to Beijing and Shanghai. Canada iShare tracks the MSCI Canada Index which has a 40% exposure to the Canadian energy and materials sector.
Starbucks?
And what about Starbucks (SBUX) as a China play? Starbucks has some 9,000 stores worldwide and in the first quarter of 2005 its sales increased 27% and its revenue exceeded 100 million dollars. It entered the Chinese market in 1999 and has some 300 stores that have exceeded 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 new status-conscious youth affluent, Starbucks expects China to be its second-largest market soon. During my recent trip to China, I visited ten Starbucks stores and all of them were bustling with lots of young Chinese people enjoying not only the coffee products, but also the higher margin specialty drinks. Do you think the Chinese will always prefer tea? Japan shows that when income levels reach certain tipping points, consumer preferences shift from tea to coffee. Starbucks always seems expensive, but many large companies always are. Starbucks investors multiplied by 43 their investment in its 1992 initial public offering and revenues increased 27% in July.
China represents a huge opportunity for long-term investors, but an indirect approach may be the smartest strategy.
Next Week: Find Out What’s The Next Big Asian Bull Market In The 21st Century – Hint: “It’s Not China!”
Carl Delfeld is a director of the global advisory firm Chartwell Partners and editor of the Chartwell Advisor and Asia Investor Intelligence newsletters. He served on 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