Oriental exposure

Harvey Jones investigates a fund which aims to take full advantage of one of today’s most exciting markets

Greater China has delivered excellent returns to offshore investors during 2003, growing a sector average of 42 per cent since the start of the year and 36 per cent in the six months to mid-October, according to Standard & Poor’s.

Schroder International Selection Fund’s Greater China four-star Micropal-rated fund, which invests in China, Hong Kong and Taiwan, outperformed the sector average, growing 46 per cent since 1 January and 42 per cent during the last six months. So what does the future hold for investors in China, and Schroder’s Greater China fund in particular?

Spectacular growth

The China miracle growth story invites envy and admiration from countries across the globe. Its economy is growing at around 8 per cent a year, faster than any of the G7 economies, and some analysts predict it could overtake the US within 50 years.

It has a greater trade surplus with the US than Japan, and last year overtook the UK as the world’s fifth-largest exporter, contributing 5 per cent of global exports. To cap it all, in October it became only the third nation to send a man into space.

Yet China also faces some major challenges, both internally and from its international competitors. The country lingers at 96th on the UN Human Development Index, regularly draws criticisms over its human rights record, and is only just recovering from global panic over the deadly Sars virus.

Trade competitors, led by the US, have also complained that China’s currency, the renminbi (RMB), or yuan, is pegged at an artificially low rate to the dollar, giving it an unfair trade advantage and costing jobs and exports elsewhere, and are pressing for revaluation.

Schroder ISF Greater China was launched in March 2002 to accommodate shareholders from the Schroder China Dragon unit trust, launched in May 1997 (on which performance figures prior to March 2002 are based).

Fund manager Louisa Lo assumed the reins in August 2002. She has also managed Schroder Taiwan for the last three years and Asian Emerging Markets, which invests in Taiwan, Korea, India and China, since early 2002, plus a number of institutional portfolios.

She says the future is looking bright for China, and expects recent good news to continue. “China has enjoyed extraordinary growth in recent years, which has averaged more than 10 per cent a year in some major cities.

Domestic consumption is stable and the middle class is growing wealthier, especially in urban areas. They are starting to buy white goods such as refrigerators, and some are graduating up to cars.

Nationally, retail sales grew 9.9 per cent in the year to August.”

One drawback is that China’s trade surplus shrank by 87 per cent in September compared with the same month in 2002, as consumers’ growing spending power sucked in imports. Consumer credit and rising debt are new features of the Chinese economy, but Lo doesn’t see these factors as a major threat.

“Export growth to markets such as the US remains strong, and I don’t expect any sharp slowdown in the immediate term. The middle-class are borrowing and spending more, but the savings rate is 40 per cent, which is very high compared to developed countries.”

China remains a major draw for global companies looking to cut their cost base. “Multinational companies are relocating factories from the US, Mexico and Europe. China has an almost unlimited supply of cheap labour and its infrastructure has improved, encouraged by local government to attract foreign direct investment,” she says.

Political pressures

China’s premier Wen Jiabao is resisting growing international pressure to let the RMB appreciate or even float the currency freely. The stakes are high for the Chinese: ratings agency Standard & Poor’s warns that China risks its debt rating and the stability of its banking system if it does ease controls.

The upcoming US presidential election may trigger a new round of trade disputes that could potentially slow China’s exports over the next 12 months, especially for light-industry products such as textiles and garments, but Lo doesn’t expect major long-term troubles.

“The US does have a major trading deficit with China, but even if the currency were revalued, I doubt this would persuade multinationals to return to the US or Mexico.”

The Chinese economy was untroubled by the relatively smooth handover of political power in March, when president Jiang Zemin stepped down after 10 years and was replaced by Hu Jintao. It is also emerging from the economic impact of Sars, which cut foreign direct investment by 28 per cent, or $3.3 billion, in August alone, because investors were discouraged from visiting China to sign contracts.

“The government dealt with the Sars crisis aggressively, transparently, effectively and in a cooperative manner. There was no hush-up, and you have to give credit to them for that. There was a lot of talk about Sars earlier this year, but the impact was quite limited and I can’t see it causing any long-term problems now.”

Chinese markets consolidated during September, with investors taking profits on H-shares, Chinese companies listed in Hong Kong, following reports that China would reduce tax rebates for exporters from January 2004 to ease pressure on the RMB.

Schroder ISF Greater China is invested roughly 55 per cent in Hong Kong, 21 per cent in China and 21 per cent in Taiwan. It was aggressively overweight in China three months ago, but Lo has shifted its position to neutral. “You have to be very disciplined when investing in China and prepared to take your money out at the right time.

A lot of shares were trading at the high end of their historic values and we have been taking profits, notably on H-shares, by selling shipping for example.” The fund is invested about 28 per cent in financials, 20 per cent in industrials, 18 per cent in information technology and 14 per cent in consumer discretionary.

Monetary tightening in China is putting pressure on cyclical sectors such as property, steel and iron. Lo remains cautiously optimistic about the market outlook for China, favouring transport stocks and selective consumption shares, while avoiding the property and steel sectors.

Hong Kong and Taiwan

The Hong Kong economy has revived in recent months, enjoying a pick-up in tourism after China eased travel laws which forced its citizens to visit the city only as part of a group. “We are currently overweight in Hong Kong, where companies should benefit from a recovery in the domestic economy and greater exposure to China, with its cheap labour and infrastructure. We are investing in small banks in Hong Kong, where there is potential for mergers and acquisitions.”

The fund is “slightly underweight” in Taiwan, increasing its weightings following a recovery in consumption and the domestic property market.

“There is a lot of political noise about Taiwan, but it is still one of the biggest investors in China. Its major companies are building big factories in Chinese cities and there are increasing integration and closer business links.”

Lo warns that expectations for Hong Kong and Taiwan are currently inflated – markets could prove volatile ahead of the elections in Taiwan next March, but should pick up thereafter. Hong Kong and Taiwan also depend heavily on the global economic recovery, particularly a pick-up in US consumer spending. “China is a little more self-contained and better placed to cope, but will still be affected by the external business environment, because exports are a major economic driver.”

Schroder ISF Greater China has enjoyed increased inflows from investors in recent months and has seen assets under management rise from $62 million to $82 million. “Our fund has a decent track record and a nice geographical diversification across the greater China area, making it less vulnerable than a pure China story.

We are disciplined investors, with a lot of emphasis on bottom-up stock picks. Schroder has a well-established research team covering greater China and the story across Asia, and that helps our stock-picking. Greater China has great potential, and we hope to deliver strong returns to investors,” Lo says.