Zaks Investment Advisory Service

How Americans Can Invest in Chinese Shares

Last time, we talked about various classes of Chinese stocks and about the exchanges that trade them, both in China itself and outside its borders. We will discuss what opportunities are open to American investors in this market in a moment, but first I would like to comment on last week’s financial events. And not even so much on what happened on the stock exchange itself, but rather on how the financial press reacted to the latest events.

As you may remember, the week started off with a market drop, continuing the previous two weeks’ trend. The commentary adopted a completely mournful tone, and many newspapers and Internet sites started talking about a recession as if it were all but inevitable. One could be forgiven for thinking that standing on the threshold of future financial cataclysms, it was time to dump all shares, and the sooner the better. I hope that my listeners did not panic or listen to this advice. On Tuesday, the market went up and continued to rise until the end of the week. From the moment the market closed on Monday, November 26 through Friday, November 30, the S&P 500 index gained 5.2%. Of course, I do not want to say that the market will continue to grow at the same rate. I would simply like to point out that the financial press creates lots of noise, which often is only marginally related to what is actually happening to the economy and the financial markets. It is not particularly sensible to make decisions based on this noise.

And now, let us return to Chinese shares. Why have I devoted so much time to them? Because it would make sense for a lot of investors to diversify their portfolios and invest parts of them in Chinese financial instruments. As we have already said, diversification is possible not only through investments made in different sectors of our economy, but also through ones in securities of various countries. Not all investors should be placing money in Chinese stocks, and, of course, only a small part of the portfolio may be invested in these instruments. For the most part, these plays are for people who are more tolerant of investment risk. But there is no sense in completely ignoring Chinese shares. China is a fast-growing economy. Several years will pass, and China’s economy will become the world’s second-largest. For those who invest money over the long-term, Chinese shares represent one of the very interesting options. Of course, one should remember that Chinese markets are still not very transparent, that they are frequently manipulated by the government, that they are home to incessant insider trading, and that their share prices often fail to reflect economic realities. In other words, should you invest a part of your money in Chinese stocks, you must understand that this is a risky investment, more risky, for example, than buying shares of American companies. Nevertheless, Chinese stocks offer opportunities that securities in other countries fail to do.

How can Americans invest in Chinese shares? This may either be done directly or through other financial instruments, ones like mutual funds and closed-end funds, and ETFs, or exchange-traded funds. Directly, as I already said in our previous program, one may purchase so-called ADRs, or American Depository Receipts, which are financial instruments issued by American banks after they first take as collateral a corresponding number of foreign shares. Around 50 Chinese companies have issued ADRs on the US market: from giants like PetroChina, which we already mentioned, China Telecom (CHS) and China Life Insurance (LFC), to relatively small companies. They represent almost all sectors of the Chinese economy. And even though there is an opportunity to buy these shares, I would not recommend it for my listeners. The fact is that, as I have already mentioned, the financial disclosure presented by the Chinese companies does not correspond to American standards. Direct investments in Chinese shares should be made by professional investors who have access to the most varied sources of information. I believe that for average investors, it would make far more sense to participate through investment funds, which allow risk diversification.

There are more than 20 mutual funds that specialize in China. No other country attracts as much attention from investment managers. I will not go through all their names since you may find them yourself on the Internet, or by turning to your investment advisor. I would like to note the following: even though many funds call themselves “Chinese,” they invest money in all sorts of different companies: in Chinese ones whose shares are traded on the Shanghai and Shenzhen exchanges (the so-called Class B shares), or ones in Hong Kong and sometimes even companies in other East Asian countries. One has to be very careful and read the prospectus, when possible, before making the investment. Second of all, many of these funds are very expensive, i.e. they have high expense ratios. Often, in my opinion, these expenses are unjustifiably high, and one should also bear this in mind.

Besides mutual funds, there are also closed-end funds that specialize in Chinese shares. At least one of them invests money in Chinese Class A shares. This represents a rare opportunity for Americans to participate in a class of shares that are mostly intended for Chinese investors.

And with this, we will draw today’s program to a close. We will talk about exchange-traded funds that specialize in China in our next program. This was Sergey Zaks. Thank you for your attention and until next time.