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How to Invest in China's Year of the Snake

CHINA FOCUS: Investment trusts, OEICs and ETFs for gaining exposure to the volatile land of Eastern promise

Jackie Beard, FCSI 7 February, 2013 | 6:24PM Holly Cook

On 10th February we enter the year of the water snake, according to the Chinese Lunar calendar. One of five snakes—the others being wood, metal, fire and earth—the water snake last reared its head in February 1953. That’s the year in which Chairman Mao Zedong introduced the five-year plan in an attempt to boost Chinese industry. Each factory or mine was given an output target and failure to meet these targets was seen as failing the Chinese people. It’s also the year in which all private companies were brought under state control.

Under Chinese Taoist philosophy, water is representative of intelligence, wisdom and flexibility. These are important characteristics we look for in a manager when researching funds at Morningstar.

Roll forward some 60 years and it’s a very different picture. While there are still many state-owned firms, there are an increasing number of listed businesses in which foreigners can invest. Indeed, there are some 350 funds investing in Chinese equity that are available for sale in the UK, spanning all vehicle structures. Our analysts have assigned opinion-based ratings to 21 of these OEICs, investment trusts and ETFs.

Under Chinese Taoist philosophy, water is representative of intelligence, wisdom and flexibility; but too much water can cause difficulty in making a choice and sticking with it. Apply that to funds and it’s easy to see how an investor can be confused, given the sheer number of funds from which to choose. But let’s not forget what water symbolises: intelligence, wisdom, flexibility. These are important characteristics we look for in a manager when researching funds at Morningstar.

From the 350 funds in Morningstar’s China Equity and Greater China Equity categories, just one has earned our analysts’ top rating of Gold and only one other has won Silver. These are both opened-ended funds, while our closed-end fund coverage highlights two investment trusts with Neutral Analyst Ratings.

Let's start with one of the most famous by reviewing our closed-end candidates.

Investment Trusts

Fidelity China Special Situations
Neutral Analyst Rating

Among the 21 China equity investment trusts rated by Morningstar analysts are Fidelity China Special Situations (FCSS), run by the legendary Anthony Bolton, and JPMorgan Chinese (JMC), run by Howard Wang and his team. Both funds carry our Neutral rating, but for different reasons.

As the year of the water snake rolls into the year of the horse in 2014, Fidelity’s Bolton may be approaching the end of his tenure. As things stand, he has committed to running the fund until April 2014 and we expect some clarity this year on whether he will continue beyond this date, but it’s not long enough for us to have conviction and award a positive rating as we take a longer-term view than just 12 months.

Indeed, we think all investors should take a long-term view when buying into funds, particularly those with narrow mandates such as Chinese equity and where a key part of the attraction is the country’s long-term growth prospects.

JPMorgan Chinese
Neutral Analyst Rating

The second investment trust—JPMorgan Chinese—has a longer track record than its Fidelity counterpart. Launched in 1993, it has a slightly wider investment remit, encompassing Taiwan as well as Hong Kong and China, so asset allocation calls between the countries are a key factor here and this is where our conviction is muted. The team’s top-down views in recent years have met with limited success and it’s affected the fund’s returns relative to both its peers and its benchmark.

Open-Ended Funds

First State Greater China Growth
Gold Analyst Rating

While our analysts have reservations about the two afore-mentioned investment trusts, there’s no such concern about this open-ended fund from renowned emerging markets managers First State. First State Greater China Growth has earned our highest Analyst Rating—Gold—and is described by Morningstar OBSR analyst Amaya Assan as “an excellent choice in the region.”

Lead manager Martin Lau is an experienced portfolio manager in the Asia Pacific (ex Japan) team and he’s supported by members of the emerging markets team, First State Stewart, in Edinburgh, Singapore and Hong Kong. The team’s strategy means that the fund performance can be fairly volatile, but our analysts believe strong management gives it a solid chance of maintaining its strong track record. This fund was soft-closed to new investors in January 2012.

Fidelity China Focus
Silver Analyst Rating

Not only is there a lone Gold-rated China equity fund  under Morningstar’s coverage but there’s also only one that has earned a Silver rating from Morningstar analysts. Fidelity China Focus has continued to impress our analysts, with its consistent performance, stable managements and depth of research.

Manager Martha Wang believes the mid-cap space offers the most compelling opportunities to identify quality Chinese companies at relatively cheap valuations. There’s a limit to the amount of mid-cap exposure she can hold given the size of the fund but analyst Sunny Ng believes the fund can “provide investors with some comfort” as they navigate the volatile Chinese equity market.

Exchange-Traded Funds

Value China ETF
5-Star Quantitative Rating

For investors preferring a passive approach to investing in Chinese equity, there is just one exchange-traded fund in the two Morningstar China Equity categories that currently carries a 5-star Morningstar Rating. Value China ETF's five stars represent a risk-adjusted measure of the fund’s performance over the past three years and mark that the fund has outperformed its category peers. Indeed, Value China ETF gained 17% in 2012, beating the category average by 6%, and has already rallied another 12% in the first five weeks of 2013. But the 15% drop recorded in 2011 is a stark reminder of how treacherous investing in China equity can be.

Morningstar ETF analyst Al Kellett warns that investors looking to get exposure to Chinese equities should be mindful of which underlying benchmark they choose to track, as there are meaningful differences across the various indices focused on this market. The FTSE China 25 Index is concentrated within a much smaller number of holdings than the MSCI China, which has 135 constituents, or the CSI 300.

Value China ETF tracks the FTSE Value-Stocks China Index, which consists of 25 quality value stocks amongst liquid and tradable Chinese companies' shares listed in Hong Kong, including H-shares, Red chips and P chips. This ETF is listed on the Hong Kong Stock Exchange.

Lyxor ETF China Enterprise
3-Star Quantitative Rating

For investors looking for China ETFs traded on local markets, the Lyxor ETF China Enterprise (ASI) is listed on EURONEXT Paris and has a LSE-listed share class. This second ETF tracks the Hang Seng China Enterprises Index, a free float market capitalisation-weighted index of 40 of the largest H-share companies listed on the Stock Exchange of Hong Kong. The fund’s total expense ratio (TER) is 0.65%, which is pricier than some of the alternatives offering exposure to Chinese equities.

As with the previously-mentioned ETF, this Lyxor offering also bears the scars of China volatility. A 43% surge in 2009 gave way to a lacklustre performance in 2010 and a 20% drop in 2011. The fund has marginally outperformed its category average in the past three years, earning it a 3-Star Morningstar Rating and has so far gained 10% in 2013.

Holly Cook co-authored this article.

Use Morningstar's Fund Screeners to find funds that meet your chosen criteria.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author Jackie Beard, FCSI

Jackie Beard, FCSI  is director of closed-end fund research with Morningstar UK.