China's consistently strong economic growth hasn't helped its stock market this year. During the first six months of 2008, the benchmark CSI 300 index, representing stocks traded on the mainland, plummeted 48%. Meanwhile, Hong Kong's Hang Seng index fell 20.5% year to date through June 30, even more than the 12.5% slip in the Standard & Poor's 500-stock index.
What's behind investors' bearish outlook? Soaring costs of oil and raw materials are squeezing profit margins at companies in China's manufacturing-driven economy. The government's attempts to rein in inflation have made the markets nervous, and there are worries that the economy may lose momentum following the Beijing Olympics in August.
Given all that, is it time to stop investing in China? Investing in emerging markets is always a risky game, and China is no exception. But despite the volatility, many fund managers seem happy with their holdings in China, and expect good returns in the long run. What boosts their confidence? China's growing middle-class— and rising levels of disposable income.
Upbeat About Future Growth
"Our philosophy is to look for promising companies with great business models at discounted valuation," says Lei Wang, co-manager of Thornburg International Value Fund, where Chinese stocks account for 5% of the $19.1 billion total diversified investment.
Among Thornburg's top holdings in Chinese stocks, Wang specified three keepers: Hong Kong Exchanges & Clearing, China Mobile Communications (CHL), and China Life Insurance (LFC).
Although Exchanges, which operates stock and futures exchanges as well as their related clearing houses, was down 48% in the first half of the year, Wang is upbeat about its future growth. Wang predicts more money from mainland China will go overseas, both from institutional and individual investors. "Exchanges eventually will allow dual listing by foreign companies and become the first parking lot for those who seek global investment diversification," says Wang.
China Mobile, with 407 million subscribers, is the largest and still the fastest-growing mobile phone operator in China. It's difficult for its two major competitors, China Unicom (CHU) and China Telecom (CHA), to play catch-up while China Mobile boasts the best network and 87% share of the market of new subscribers. With Apple (AAPL) abandoning profit-sharing arrangements with carriers that offer its popular iPhone, China Mobile will probably to be the one to introduce iPhone to China, says Wang. "China Mobile will maintain its dominance in the market," Wang said, "and unlike many global wireless phone companies, it doesn't have any debt."
More Domestic-Driven Stocks
So far, life insurance has low market penetration in China. While the industry accounts for 4% of U.S. gross domestic product, it only takes up 1.7% in China. The annual premium per capita in China is $34 vs. $1,700 in the U.S., but China's citizens need to budget for their health since the government no longer takes care of them from cradle to coffin. "China Life is in the sweet spot to catch that growth," says Wang.
If Thornburg's approach to Chinese stocks is more bottom-up—looking into individual companies—Matthews China Fund (MCHFX) has a broader grasp of consumer sectors. Its $1.4 billion investment in Chinese stocks covers tourism, retail, real estate, telecommunications, and financial industries. "The Chinese economy will be less export-dependent and more domestic-driven," said Richard Gao, the lead fund manager. As it is for most investors, for Gao, diversification is key. "We like companies that have diversified businesses across China, not just in top-tier cities," he says.
Among Matthews China Fund's top 10 holdings:
Shangri-La Asia
According to Gao, the five-star hotel chain has established a strong brand in Asia. It has 36 hotels in mainland China, more than half of its Asian outlets.
Lianhua Supermarket Holdings
The country's No.1 grocery retailer operates more than 3,600 supermarkets, hypermarkets, and convenience stores in 21 Chinese provinces. The three different retail formats are benefiting from the rising consumer class.
Li-Ning
With more than 5,000 stores in China, the leading domestic sportswear brand plans to expand in smaller cities in western and southern areas. "The company has invested heavily in research and development and branding while outsourcing manufacturing," said Gao. "The strategy has paid off."
NWS Holdings
This Hong Kong company invests heavily in all types of infrastructure in China, from toll roads, power plants, and water treatment to exhibition space and transportation.
SINA(SINA)
According to Gao, China has the largest Internet user base in the world, and Sina.com is the most popular Web portal in China with a more than 30% growth rate.
China Merchants Bank
"It's the best-run bank in China," says Gao. "Compared with other state-owned banks, it has a more experienced management team." He also likes China Merchants' wealth-management business.