China’s inscrutable monetary strategy
Aim: 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 I return from a three-week trip to Asia left a number of questions unanswered. The basket of currencies that is supposed to determine the value of the yuan going forward 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 further speculation in the short term, as most economists believe that the yuan is undervalued by 10%. and 20%. With $1 trillion in business transactions each 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 the 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 rise of the euro 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 investment options in China do not 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. A leading online bank ranked “Best on the Web” by Forbes, Everbank offers a variety of global currency accounts, as well as FDIC-backed three-month and six-month CDs that offer attractive rates.
iShare Direct Approach
Another play of direct capital from China is through China iShare (FXI) which tracks the FTSE/Xianhua China 25 Index which is made up of 25 of the largest and most liquid Chinese names. FTSE is a UK-based index company and Xianhua is a China-based media company.
The 25 shares 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. The broader Xinhua China Index includes 1,355 publicly traded 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 sectors in China: energy (20%), telecoms (19%), and industrials (18%). This concentration can be seen as a plus or 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 the Asia and China region. Keep in mind 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 property markets have a ways 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% below 1997 levels. Being the last Asian currency pegged to the dollar should encourage inflows 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 currency game
China’s move last week will also add to appreciation pressures for other undervalued Asian currencies. To compete with China’s export machine, many Asian countries have been reluctant to let their currencies rise, but now have a bit of leeway. Malaysia’s ringgit broke free of its peg to the dollar last week and rose 0.7% on the first day. While 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 publicly traded 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 broadly 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 indirect move by China would be to invest in Canada iShare (EWC). The Chinese are going on a buying spree at Canadian energy companies and recently invested $2 billion to build a thousand-mile pipeline from the Alberta tar sands to the port on the west coast and on to Beijing and Shanghai. Canada iShare tracks the MSCI Canada Index which has a 40% exposure to Canada’s energy and materials sector.
Starbucks?
And what about Starbucks (SBUX) as a China play? Starbucks has some 9,000 stores around the world and in the first quarter of 2005 its sales increased by 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 expects to expand to 30,000 stores, and China is a key part of its expansion strategy. With 250 million Chinese moving closer to the middle class and millions of new youth aware of their affluent status, Starbucks expects China to be its second largest market before long. During my recent trip to China, I visited ten Starbucks stores and they were all very busy with a large number of young Chinese 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 turning points, consumer preferences shift from tea to coffee. Starbucks always seems expensive, but many big companies always are. Starbucks investors increased their investment 43-fold in its 1992 initial public offering, and revenue increased 27% in July.
China represents a huge opportunity for long-term investors, but an indirect approach may be the smarter strategy.
Next Week: Find Out What’s The Next Big Asian Bull Market In The 21st Century: Hint: “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