Skip to main content

The China Fund Syndrome

A new mutual fund tries to capitalize on the frenzy over Chinese stocks.

World stock markets are hot and you can barely find a sector or region that isn't way up in the last year. This environment incites investors to take on more risk, not cut back. Owning a fund that was up 35% last year doesn't create happiness for investors -- it creates envy for markets and funds up 100% or more. China fits the bill.

As fear becomes optimism, the fund industry rolls out products to satiate the appetite of investors ready to take on the world, after licking their wounds in safe U.S. treasury bills. They want a story of boundless prosperity and potential profits. China delivers on all fronts.

Frenzy Over China

You can't watch TV or read a financial publication today without hearing about China. China and the huge trade surplus; China and Internet growth and stocks up 1,000%; China and the fastest growing GDP; China and the undervalued yuan; Chinese citizens with money to burn -- ready to stop riding bicycles and start maxing out credit cards.

A world of obese Chinese driving home in SUVs loaded up with consumer spoils from the mall, yapping on cell phones and eating fast food is surely right around the corner. Compared to a maxed-out, unemployed, stagnate wage-earning U.S. consumer, the smart money is betting on this new wave of prosperity.

Or at least that's what a national advertising campaign for the recently launched

China-U.S Growth Fund

by Fred Alger & Company implies.

The new fund breaks from the typical China-oriented fund by placing about half the portfolio in U.S. companies doing business in China and half in Chinese stocks. This means investors in the fund will own

Yum! Brands


, which apparently does a bang-up business hocking KFC to the Chinese, and



, currently building a brand in China alongside



and other less speculative Chinese stocks. The fact that these U.S. multinational companies currently do less than 5% of their worldwide business in China isn't the issue -- they're there early and will profit from the region's growth.

The exact fundamentals of the Chinese market are cloudy. Part of this is because the Chinese government is behind on some data. Alger executives could only give vague ranges for total market cap in China, the GDP, or P/E ratios although the dividend yield was quite clear -- zero. This line of questioning was cut short because, "it's not relevant" to this market, which is in its infancy, and doesn't "mean anything". This is a long-term opportunity.

Those looking for more information on the fascinating growth story going on in China can check out a report soon to be available on the Guinness Atkinson funds Web site, managers of the no-load

Guinness Atkinson China & Hong Kong


Jim Atkinson funds have been selling well this year after the recent hot performance and investor enthusiasm, but were less of a draw a year ago. He likes the China story and can back it up with some amazing facts to be released in the report. It's a good story and it is real. So was the growth of the Internet. Unfortunately, investment returns don't always parallel underlying growth.

While Alger manages the U.S. side of the portfolio, it has hired subadvisors to manage the Chinese side of the equation. This is fortunate because while Alger has 40 years of U.S. investing experience, it has no emerging market experience. This fund represents its first mutual fund foray into a foreign market.

JF International Management, formerly known as Jardine Fleming, is the investment management company hired to manage the Fund's Chinese portfolio. JFIM is now part of J.P. Morgan Chase.

JF also manages a lower-fee (China-U.S. Growth has an expense-capped 2.4% annual fee) closed-end fund targeting China, the

JF China Region Fund

(JFC) which debuted in 1992, shortly before the last speculative peak in Chinese shares. Investors who bought that fund 10 years ago are still down more than 10% even after last year's 100% plus showing. Apparently they invested in the Chinese growth story a little too early.

In addition to the JF China Region Fund, there are several closed-end funds investing in China. Direct plays include the

China Fund

(CHN), the

Greater China Fund

(GCH), and the

Templeton Dragon Fund

(TDF). All were launched around the same time, in the 1992 to 1993 period, when China optimism last ran high. There are also several funds that invest more broadly in the region, and include shares from other hot (and more established) markets like Korea.

Today many of these closed-end funds are trading at a premium to Net Asset Value -- a sure sign of investor enthusiasm as investors seem perfectly willing to pay $1.17 for $1 worth of Chinese stock. Directors at the China Fund seem to see the great selling opportunity a premium to NAV creates and have been selling shares of late. In early January the premium of the China fund broke 50%. The market price of the fund has already fallen over 25% since the last insider sale in early January. Traditionally these funds trade at a deep discount to true value because investors want nothing to do with China and emerging markets after they slip.

For investors who do not want to pay a premium for their China stocks in a closed-end fund, or pay a 2.4% expense ratio with a 2% short-term redemption fee as is the case with the new Alger fund, Barclays Global Investors will soon be able to fulfill your needs. They have recently filed to launch the iShares FTSE/Xinhua Hong Kong China 25 Index, the first China ETF for the itchy trigger finger investing public.

iShares has a history of launching products at the peak of investor enthusiasm. Today most of their ETFs trade lower than the price at launch as the decision to launch a new ETF usually signifies a market top. The iShares DJ Telecom index (IYZ) launched in mid-2000 comes to mind.

ETFs make money for proprietors from trading activity in the shares and the asset base. Both need to be huge to make the low-fee product economically viable. Unfortunately for longer term investors, what speculators want to trade the most tends to fall the hardest shortly after peak interest.

Alger's timing with fund launches has been less than perfect. The 40-year-old firm made the decision to enter the U.S. stock market with its first mutual fund within a year of the 1987 crash. It had an equally impressive national advertising campaign back then to announce the new foray into funds that detailed the opportunities in U.S. stocks.

Retail Phenomenon

China as an investing concept appeals primarily to no-load, retail investors. While some of the oldest China funds are load funds, they have far less in assets then their newer, no-load brethren. This is in stark contrast to a world where load funds out sell no load.

The load

Eaton Vance China Greater China Fund

, launched in 1992, now has less than 25% of the $476 million in the no-load

Matthews China

fund, launched in 1996. Much of the explanation for this gap is greater performance. The no-load Guinness Atkinson China & Hong Kong fund at $129 million has more in assets than either the Eaton Vance fund or the load

AllianceBernstein Greater China 97

fund with a track record similar to the latter.

Matthews, a boutique firm known for its Asia funds, has brought in over a billion dollars in new assets over the last few months into their funds -- a remarkable level for a small family. Its China fund had just over $100 million in assets six months ago.

Such remarkable asset growth (and the fat profits it creates for managers of high fee emerging market funds) leads to many "me-too" fund launches as others seek to get on the gravy train. Most Internet funds were launched after earlier funds brought in hundreds of millions in new assets after hot runs.

Alger, a load fund family, at the zero hour decided to shift gears and launch the fund as a no load. It says there is solid interest from the brokerage community, but the differing assets and sales volume of no load to load funds in this category say otherwise.

There is some irony that Alger, a fund family that is no stranger to the fund-timing scandal, would launch a fund in a category most prone to fund timing. A watchable small asset base and 2% redemption fee should keep fund timing at bay. As the fund is half U.S. stocks, other pure-play funds would provide a far more lucrative timing vehicle. Alger is nonetheless using fair value pricing, a sometimes controversial way to minimize the gap between true and last-quoted market prices.

The Future for China

Emerging market fund articles typically offer the perennial "advice" that these funds have high fees and are very risky, while investors can still get plenty of emerging market exposure in a more diversified and safe international fund. This analysis misses the most important aspect of emerging market fund investing: that the single biggest mistake investors make is not investing in emerging markets in the first place, but how they invest in emerging markets.

Retail no-load fund investors' worst tendencies to buy high and sell low are exaggerated with volatile funds. The media is partially to blame. There are only two kinds of articles about emerging markets. The ones that come out right after the funds are up in the triple digits, offering some tepid warnings but largely touting the bright future and remarkable profit potential; then there are the ones that come out after an emerging market crisis knocks down prices by half. In the latter case, the experts start panicking about the viability of the markets.

An executive from Alger foreshadowed this future saying it will keep the China half of the fund fully invested unless there is some great crisis at which time managers can shift to cash and U.S. investments.

There is historical precedent for this type of buy-high, sell-low behavior by emerging market fund mangers, In late 1998, at the very depths of the Russian stock market swoon (and the very beginning of a rally that has taken the market up near 1000%), the fund manager of a formerly high-flying Russian mutual fund went almost completely to cash, after his fund was down 90%.

Investors who want to invest in emerging market funds should do so when there are no ads for emerging market funds in the paper, when emerging market investing is so unattractive that closed-end funds in the region trade at steep discounts to NAV.

If you invest when new funds are being launched and touted, be careful.

When will this shift from advertising to crash happen? It could be one month or one year, but who cares? Speculators move in when everybody wants in, trying to capture the exciting last few big moves, which works for some, but not for others. Longer term investors should move in when there are no buyers.

The buying opportunity will come. The Chinese market will start slipping on some frightening stories, tales that will be dismissed by recently ordained China investing experts as minor hiccups on the road to great wealth. Possibly currently dormant inflation will pick up in China, or a massive round of debt defaults and bad loans will surface after years of too-easy access to capital for growth and a blind eye to underperforming loans. The market will then tank hard, 40% or more. Closed-end fund investors will lose more than 50% as funds with premiums swing to discounts, magnifying the bad situation.

Don't invest in China when the bulls are loose. Some day they'll come home, bloody, winded and scared, after getting skewered by the unpredictable market matador. Some day there'll be another wave of articles in prominent publications about China, in a decidedly more frightening tone. These articles won't have an ad next to them by a fund family that has no business being in China in the first place. That's when you jump in, and pick up the pieces.

Jonas Max Ferris is co-founder of, a fund research and analysis company, and partner in an investment adviser offering managed accounts in mutual funds. He welcomes column critiques, comments or baseless accusations at