News of the historic U.S. trade agreement with China two weeks ago sparked frenzied buying of stocks with "China" in their names.
While such a knee-jerk reaction is ridiculous, the trade deal is a moment for investors in international mutual funds to wonder whether and to what extent the 1.2 billion souls in China should be represented in an investment portfolio.
Events heralded as the opening of economic opportunities for the West in China occur at least twice a decade, a frustrating reprise for investors who have been drawn there only to find disappointment and frustration.
In 1997, for example, promoters of China-oriented investments were certain that the hand-over of Hong Kong from British to Chinese rule would unleash sure-fire opportunities. Instead, we got successive Asian financial crises in 1997 and 1998 and continuing rumors that China would be forced to devalue its currency.
Ralph Wanger, chief investment officer at Chicago-based Wanger Asset Management and a longtime China-watcher, said he believes a major fallacy regarding China is "the billion-people syndrome."
"Everybody says, 'Gee, if we were in China and everybody bought one serving of chicken wings from us, we'd be rich,' " he said. "What happens is you go there and you don't sell a billion pieces of chicken. The Chinese so far have been very difficult to make money with."
In that respect, the lure of China is similar to that of an emerging technology. Many years ago a few people asked: What if everyone were to buy a cellular phone and a personal computer? The profit opportunities would seem enormous. Only recently has that dream begun to be realized.
Investing in China, like most business problems, is less a matter of timing than a problem of segmentation. Despite the profit potential implied in China's entry into the World Trade Organization, no U.S. investors would reasonably place all of their assets in Chinese equities.
Managers of international mutual funds, like investors in computer technology, will follow different approaches. Some will be early adopters--pioneers willing to take the risk of following the wrong leads on the treacherous road to capitalism in China.
Others will take a show-me attitude and wait until the way seems clearer. Given the wide array of international mutual funds, investors can chose which path to follow.
Early-adopter funds enjoying gains in the enthusiasm over the U.S.-China trade agreement--such as the Van Eck Asia Dynasty Fund and the Guinness Flight Mainland China Fund--had been increasing their portfolio weightings there for months.
They invested not only in anticipation of the trade deal but also in response to what they see as favorable economic trends in China, including declining inflation, rising retail sales and greater exports, now that the latest Asian financial crisis has subsided.
The actual signing of the trade deal, therefore, was icing on the cake for these funds. In particular, the deal would enable Chinese businesses to obtain financing from non-Chinese banks and bring long-awaited competition to China's telecommunications sector. The agreement also promises to curtail the costly impediment of Chinese distributors and allow foreigners to sell directly to Chinese consumers.
"I had been taking the view all along that there was too much at stake for [the trade agreement] not to go through," said David Semple, co-manager of the Van Eck Asia Dynasty Fund. "It is deeply significant for China in the long run for maintaining the reform momentum."
Adrian Fu, manager of the Guinness Flight Mainland China Fund, said: "Our Mainland China Fund has delivered decent performance because we already had an overweight asset allocation in export-oriented [Chinese] stocks since China and the U.S. started the first round of negotiations back in April.
"We managed to ignore the negative news toward China's [World Trade Organization] entry between May and November, such as the bombing of the Chinese Embassy in Belgrade, because we thought that the solid recovery in Chinese exports was more important."
Fu predicts investors will now cash in profits from the recent rally or sit on their hands until after the possible year 2000 computer problem is resolved. "Market liquidity should then improve in January next year as fund managers reposition their portfolios," he said.
That makes December a good time to pick up bargains, he said.
Wanger, whose organization manages several international portfolios, including the Acorn International Fund, has long urged U.S. investors to increase their exposure to international equities. He said he believes China can be the next Japan, in terms of Japan's surge in economic prosperity and equity market growth from the 1950s through the 1980s. But Wanger is not an early adopter of the Chinese miracle story.
"They are still a poor country," he said. "The legal system is quite primitive. There are no securities laws that mean very much. There is no bankruptcy law that means anything.
"They are still doing things in a highly dictatorial, highly arbitrary . . . and highly predatory manner. It's nice to have international trade agreements, but we'll see."
"It's still going to be a tough market" for anyone doing business in China, Van Eck's Semple said. "But the size of it means they have to be there and they have to keep at it."