One tried and tested rule in investment is that the bigger and more widely shared the worry, the less likely it is to be realised. Remember Y2K and the Sars epidemic? Both produced warnings of global disaster. Neither turned out to be anything like the threat that doomsters had predicted. Contrast that with the subprime mortgage crisis, whose dimensions only became widely apparent some time after the crisis had already broken. In the years when investors should have been worrying about uncontrolled bank lending, most were too busy loading up on anything they could buy with cheap credit to notice the impending disaster that their own insouciance was helping to bring about.
On this measure, if nothing else, investors looking at China today should not have much to worry about. In the media, and on trading floors around the world, whether China’s economy is overheating and the Chinese stock market is moving into ‘bubble’ territory have been popular topics for months. Industry data shows that foreign investors have been pouring money into China-related funds for some time, reinforcing the increasing involvement of domestic Chinese investors. The amount invested in China funds doubled in the course of last year, driving the Chinese stock market higher, and prompting concerns that it could crash just as it did in 2007-08, when the Shanghai Composite Index fell by 70 per cent in 12 months.
Market pundits such as New York hedge-fund manager Jim Chanos and economist Nouriel Roubini, both notable for being among the few to predict the global financial crisis, have lent their support to the proposition that China could be the next big bubble. On the other side are those such as Jim Rogers, co-founder of the Quantum fund, and Jim O’Neill of Goldman Sachs, who argue that what the world is witnessing in China is a spectacular change in economic status that offers investors opportunities on the same scale as, say, the United States in the late 19th and early 20th centuries. Those who focus on short-term risks — corruption and cronyism, lack of transparency, dodgy accounting, intrusive government — are, they say, simply missing the point.
After 30 years of rapid growth, the Chinese economy is poised to overtake Japan as the second largest in the world, and in two decades or so it is likely to overtake the US as well. While there’s no guarantee that economic growth will produce correspondingly high returns for investors, it does not mean there won’t be a wide range of money-making opportunities in the years ahead.
The US in the early 1900s, says Rogers, was ‘right where China is today — a Wild East compared to the Wild West’. Investors should not lose a sense of perspective. ‘Imagine how uncertain America’s world appeared to the [rest of the] world in 1908. China seems just as chaotic and fraught with challenges today… In 1907, in fact, the US economy collapsed and the naysayers were jubilant. But even those who bought at the top [of the stock market] came out way, way ahead’ over time. In other words, even if the Chinese market were to fall again by half, which it could well do periodically in the years ahead, those with the patience and nerve to see it through could still be considerably richer than when they started.
This ongoing debate has been fanned afresh by news that Anthony Bolton, arguably the most successful fund manager in City history, has been tempted out of retirement to manage a new China fund for the US group Fidelity. His China Special Situations fund is looking to raise $1 billion from UK investors between now and the end of the current tax year. That makes it the largest investment trust launch in UK history and, as befits Bolton’s reputation, it is being given the full-on marketing push that only the largest global fund groups can muster. This includes paying commission to brokers, dealers and bankers who recommend the trust to their clients, something that is rare for an investment trust launch — although standard practice for unit trusts and other types of funds.
With Bolton pinning his reputation on its success, and Fidelity taking no chances that it will fail for lack of marketing effort, nobody seems to doubt that the fundraising will meet its target. The question is what happens after that. Can the Chinese fund conceivably achieve a success to match that of his UK and European funds? Every pound invested in the UK fund grew in value 148-fold over the course of his 28-year tenure as fund manager, beating the UK stock market by an unprecedented annual margin of 6 per cent.
Can he repeat the trick? One obvious problem is that, while he is uprooting his family to move to Hong Kong, Mr Bolton has only committed to run the new fund for a minimum of two years, leaving what happens subsequently open to doubt. Another is that he does not speak Chinese and will need to rely on local colleagues for scuttlebutt and face-to-face dealings with managers of local companies if they do not speak English (though many do). The fund’s fees, too, are on the pricey side.
There are unhappy precedents of other high-profile fund launches coming a cropper. The industry has an unfortunate reputation for tapping private investors for money when it’s easiest to do so, rather than when it’s in the investor’s best interest. Typically this means after a particular market or sector has had a spectacularly good run, which by its nature increases the likelihood of future disappointment.
The sceptics argue that this could be just such a time for China. The Chinese stock market is still at barely half the level it reached at its peak during the speculative run-up in 2008, which is a long way from any sensible definition of a bubble. Yet several respected professionals who have managed funds in Asia for many years, such as Angus Tulloch at First State Investments in Edinburgh, or Hugh Young of Aberdeen Asset Management, have been urging caution.
With the Chinese authorities now attempting to rein in the lending spree that their banks were ordered to embark on in 2008 (a commandment which, unlike Gordon Brown’s attempts to prod UK banks into lending more, Chinese banks implemented with frightening efficiency), their argument is that Chinese shares have run ahead of themselves and look vulnerable to a new monetary squeeze. This may not therefore be the best time to be moving into the Chinese market.
While he is well aware of the risks, Anthony Bolton remains undaunted and indeed enthused by his new venture. He has no financial need to return to fund management and the decision to put his reputation on the line in a country that he has only got to know over the last few years reflects his confidence that hunting for undervalued companies in China will favour his contrarian stock-picking style.
If the timing of the launch is not perfect, in his view there is no compelling evidence that the Chinese market is seriously overvalued. One comfort for sterling investors, he points out, is that the Chinese currency is sure to strengthen, even if nobody knows when the Chinese authorities will sanction the move. That will boost returns to sterling investors, which are likely to be higher than those on offer from mainstream UK and US equities.
An important consideration, Bolton argues, is that with GDP of $6,000 per head, China has now reached the point at which, historically, developing countries have entered their fastest period of growth. If precedents are anything to go by, this will also be the period during which an emerging middle class will embrace consumerism, leading to the rapid appearance of profitable new businesses in sectors such as retail. While the risks of corruption and political interference are real — many of China’s largest companie
s are former state-owned enterprises — he reckons he only needs to find a relatively few big winners to generate above-average long-term returns.
The track record of Chinese funds is impressive enough to give some credence to sceptics about the timing of Fidelity’s launch. Most China funds have delivered five-year returns of 15 to 25 per cent per annum, notwithstanding the meltdown in 2008-09. Many funds with longer track records have doubled their investors’ money, albeit with considerable volatility. Over the last ten years, the Wall Street and London stock markets have by contrast returned next to nothing.
One certainty is that the Chinese market, like Wall Street in the early 1900s, will be volatile for many years to come. Those with a limited tolerance for that kind of risk should obviously steer clear. For those who understand the nature of the beast, whether they buy into Bolton’s new fund now, opt for a stodgier but cheaper Chinese index fund or ETF, or wait for a better opportunity to invest in one of the many other funds now offering access to China (Jupiter, First State, Neptune, Barings, Templeton and Schroders all have decent funds that focus either on China alone or on the wider Chinese-speaking region), the longer term upside is considerable.