A Bull In China?

Opportunities abound but recent volatility requires investors to tread cautiously

You just cannot ignore the trail China has been blazing in recent years. We’ve all had more than ample opportunity to gawk at the impressive numbers put up by stocks in the nation’s Shanghai composite index—up 97% in 2007, and 130% the year prior.

A huge nation with 1.3 billion people (20% of the world’s population), China has a gross domestic product of $10 trillion but is still considered an emerging market. “There’s a general rule of thumb for investing in emerging markets,” says C. Kim Goodwin, head of equities for Credit Suisse’s asset management business in London. “When you’re just trying to get in on a fast-growing economy, you usually buy the biggest bank or a collection of the biggest banks to take a stake on growth opportunities. China has developed and matured to the point where now it’s a good time to look for specific company investments.”

A few concerns, however, probably make mutual fund investing the best way for most individual investors to approach China. While the numbers are impressive, there’s been significant volatility. Consider that according to Morningstar, a Chicago-based mutual fund research firm, mutual funds with at least a 25% stake of their assets invested in China managed a minimum 39.6% gain last year. Over five years, the average annualized return for these funds was 30.6%. As a cautionary note, this year, the same group of funds fell between 11% and 26% by early February.

Another concern is what’s going on here at home, i.e., the sputtering U.S. economy. America, after all, accounts for 19% of China’s exports, and a recession here—and in Europe’s largest economies as well—could take a large chunk out of China’s heady growth.

Morningstar analyst Bill Rocco says the most prudent way to invest is through a diversified emerging market stock fund. Two of Morningstar’s favorites are T. Rowe Price Emerging Markets Stock (PRMSX), and American Funds New World (NEWFX).

Rocco recommends investors set on China-specific funds view them as they would a single stock in their portfolio. In other words, they make sense for risk-tolerant investors with long time horizons who already hold two to three diversified international mutual funds, or for folks who have a windfall to invest. “It would also be a good strategy to dollar-cost average by investing the minimum up front and then adding a bit month-by-month so that you aren’t strapped with a huge loss over a short amount of time,” says Rocco.

A Taste of China

Fund Name (Ticker) China Equity Annual Return 2007 Total Return 3 Years Min. Initial Investment Website
Fidelity Emerging M (FEMKX) 11.2% 45.1% 34.0% $2,500 www.fidelity.com
Pioneer Emerging Markets R (PEMRX) 15.0% 41.6% 32.1% $0  
Birmiwal Oasis (BIRMX) 9.8% 29.3% 26.1% $1,000 www.birmiwal.com

EQUITY FUNDS WITH EXPOSURE TO CHINA OF LESS THAN 15% OF EQUITY ASSETS
DATA AS OF 1/31/08 SOURCE: MORNINGSTAR

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