Why Funds Are Bullish on Chinese Markets

NEW YORK (TheStreet) -- Chinese stocks have been clobbered lately. While the Standard & Poor's 500 gained 5.7% in the past year, China funds lost 20.2%, according to Morningstar. The trouble can be traced to signs that the booming economy may be slowing.

Exports to Europe have been suffering, and property prices are sinking throughout much of the country. Chinese corporate earnings growth has been slowing. Analysts expect earnings to grow 6% this year, down from an annual rate of 10% early in 2011.

But the outlook for Chinese markets is not all bleak. After their drubbing, the stocks sell for 10 times earnings. That is a bit lower than the multiples in some other emerging markets. In addition, the Chinese economy is hardly dead. The government has said that it wants the economy to grow at an annual pace of around 7.5%. To make sure that happens, the central bank recently lowered interest rates. The government has announced new infrastructure projects and subsidies for consumer auto purchases.

All that should help keep China growing briskly, says Daisuke Nomoto, portfolio manager of Columbia Pacific/Asia Fund ( CASAX). "The worst is over for China," says Nomoto. "In the third quarter of this year, we should begin to see the positive impact of all the monetary and fiscal policies."

Whether or not, the stimulus takes hold, China is likely to remain a volatile market. Trouble in Europe could send the stocks down further. Still, many investors will want to hold at least a small position in what is likely to remain a fast-growing economy.

For a solid fund, consider Guinness Atkinson China & Hong Kong ( ICHKX). During the past ten years, Guinness returned 11.2% annually, outdoing 68% of China funds. Portfolio manager Edmund Harriss looks for solid companies with improving earnings and above-average returns on investment. Harriss avoids high flyers. Instead, he prefers stocks with moderate prices that are strengthening.

"In China, it does not pay to take the most expensive stocks," says Harriss, who has worked on the fund since it was started in 1994. "You can find plenty of growing companies that sell at attractive prices."

Lately Harriss has been shying away from exporters. Their margins have been shrinking as Chinese wages rise and global demand softens. He is finding better earnings at companies that serve China's domestic economy. A holding is NetEase ( NTES), a supplier of Chinese language online role-playing games, such as Heroes of Tang Dynasty. By developing new games, the company has been reporting high returns on equity. NetEase also runs online content channels that provide news on sports and finance.

For broader exposure to Asia, a top choice is Columbia Pacific/Asia. The fund lost 2.6% annually during the past five years, outdoing 89% of funds in the Pacific/Asia category. Columbia has 11% of assets in China. The fund seeks high-quality companies selling at modest prices. The portfolio includes a range of blue-chips, such as Toyota Motor ( TM) (TM) and Taiwan Semiconductor Manufacturing ( TSM), an industry giant.

A holding is China Mobile ( CHL), the biggest wireless provider in the country with 650 million subscribers. After a period of rapid expansion, the company is growing more slowly. But portfolio manager Daisuke Nomoto says that the cash flow should continue growing as data usage increases.

For a broad emerging-markets fund, consider Aberdeen Emerging Markets ( GEGAX), which has 7% of assets in China. During the past five years, the fund returned 7.6% annually, outdoing 99% of peers. The Aberdeen portfolio managers seek companies with solid balance sheets that can deliver consistent growth.

The managers often prefer steady businesses that can grow 8% to 12% in the next year instead of faster-growing businesses that could sink in a downturn. Once they buy a stock, the managers hold on for years. In 2011, the fund only turned over 2% of its portfolio, while the turnover figure for the average peer was 81%.

A holding is PetroChina ( PTR), one of the major oil producers in the country. "They have a relatively clean balance sheet and strong cash flow," says Adrian Lim, an Aberdeen portfolio manager.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine. At the time of publication he had no holdings in the stocks mentioned.

More from Mutual Funds

High-Flying Mutual Funds Begin to Favor Energy but Tech Still Reigns Supreme

High-Flying Mutual Funds Begin to Favor Energy but Tech Still Reigns Supreme

60 Seconds: What's the Difference Between an ETF and a Mutual Fund?

60 Seconds: What's the Difference Between an ETF and a Mutual Fund?

Mutual Funds on Track for Record Year

Mutual Funds on Track for Record Year

Bitcoin Today: Prices Come Off Highs as Rally to $10,000 Pauses

Bitcoin Today: Prices Come Off Highs as Rally to $10,000 Pauses

Video: How to Select Mutual Funds in Your 401(k)

Video: How to Select Mutual Funds in Your 401(k)