China: Is it ready for prime-time investment?

(December 2, 2003) Investing in China is fraught with risk, but the country’s spectacular growth and enormous potential make it impossible to ignore, experts say.

“China has become an increasingly important player on the world stage and it’s incumbent on us as professionals to think carefully about how China is going to affect the investing we do in the months and years to come,” says Jonathan Passmore, vice-president of GE Asset Management, the sub-advisor for Talvest’s International Equity Fund.

Looking at the economic picture, Passmore notes that China has enjoyed 9.7% annual GDP growth for the last 20 years. “No other country in the world comes anywhere close to that kind of number,” he said at the recent Advisor Forum in Toronto.

In addition, direct foreign investment in China totalled $52 billion in 2002, Passmore said, more than the other nine major economies of Asia combined.

There’s also the human factor. Thirty million people are moving from rural to urban China every year, Passmore noted, and although the country is often considered a nation of producers, there’s also a growing consumer-oriented middle class.

On the negative side, China’s government is notoriously secretive and authoritarian, illustrated by controversial projects such as the Three Gorges Dam, which displaced more than one million people.

The country also has a shaky financial system, a poorly regulated stock market and weak corporate governance. “Foreign investors have no protection from doctored financial statements nor any recourse in the event of company default,” said BMO Nesbitt Burns analyst Peter Shippen in a recent report.

Still, China is concerned about its international reputation, Passmore claims, and is attempting to create a “benign investment environment” in an effort to create jobs. “If they don’t satisfy that need, you end up with social unrest and that’s the last thing China needs — a return to Tiananmen Square.”

From an investment perspective, Passmore recommends diluting the risk of investing directly in China by including international firms operating in the country. “We have two ways of investing in China, direct and indirect,” he says. “Of 100 stocks, we only have two Chinese investments that we feel meet our criteria for inclusion.”

Passmore says many large multi-nationals are operating in China, such as General Electric, Wal-Mart, French retailer Carrefour and Japanese construction equipment manufacturer Komatsu.

Multi-nationals are “increasingly taking advantage of China’s lower cost environment,” noted Shippen in his report.

“While we believe it is imprudent to directly invest in China, a few other opportunities exist which offer leverage to Chinese growth with less downside risk,” he added.

Shippen points out that Japan has emerged as an important business partner to many Chinese companies. And he adds that China — which has little natural resources of its own — has emerged as a tremendous user of commodities, such as nickel, steel, iron ore, copper and oil. Canadian nickel producer Inco has stated that the increase in demand for nickel in 2002 was largely due to China.

But it’s the longer term opportunities in China that excite portfolio managers like Passmore. “We see China with its 1.25 billion people as an enormous potential market for the future. Their economic advantage is going to last for years. China will increasingly compete with the best and brightest we have in our sophisticated economies.”

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com