New Fund Capitalizes on Hot Chinese Market

Robert Hsu, May 15, 2007

Many investors have asked me how to profit from the scorching-hot Chinese market. The market is closed to foreign investors, and until recently, there weren't any options available to us that directly profited from the exchanges in Mainland China.

The answer is that there is now a way for foreign investors to profit directly from China's stock exchanges. It's called the Morgan Stanley China A-Share Fund (NYSE: CAF). The fund gives investors direct access to China's markets because it invests mainly in A-shares of Chinese companies listed on the Shanghai and Shenzhen Stock Exchanges.

I want to stress that this fund invests directly in the hot Chinese markets, so it is likely to be more volatile than you're used to. The fund is also more speculative because it's closed-end. Closed-end funds trade just like stocks, but they often are thinly traded and subject to more volatility than open-end mutual funds.

Despite the fund's high valuation and the risks involved, I think there's a lot of upside on the horizon. Chinese shares will continue to climb, which will undoubtedly boost CAF. After all, the Chinese are sitting on a lot of money, and the only investment options available to them are the Chinese markets or real estate. (The government is currently trying to prevent real estate prices from overheating, so the stock market is really the only viable investment option right now.)

I also like the Morgan Stanley fund because it has large active positions in China's most important sectors: commercial banks (18.2%), steel (12.9%), machinery (12.8%) and oil (10.1%). The fund also invests in the growing areas of transportation infrastructure (such as road and rail), airlines and utilities. Its top holdings are China Merchants Bank, Huaxia Bank, Wuhan Iron & Steel, Shanghai Pudong Development Bank and Daqin Railway.

You may have noticed that banks are a significant part of this fund, and you may recall that I generally don't like Chinese banks. Most state-owned banks have managed to rack up a huge amount of bad loans, and they should be avoided at all costs.

But China Merchants Bank -- one of the Morgan Stanley fund's largest holdings -- is one of the few banks that I actually like. Only a small portion of it is state-owned. It's China's sixth-largest bank and the country's biggest non-state lender. China Merchants is also the most profitable lender, with a strong high-end retail banking business. In addition, it's taking market share from the four biggest state-owned banks by offering higher-margin products such as dual-currency credit cards. The bank commands more than a third of China's fast-growing credit card market, with more than 10 million credit cards issued by the end of last year. Its total number of issued credit cards will reach 15 million by year-end. To top things off, China Merchants' profit increased by more than 50% in 2006. This fund is the only way for us to participate in the success of China Merchants Bank.

In addition to investing in some of the best sectors in China, this fund will allow you to profit from China's double-digit economic growth and the strong yuan. One of the benefits of investing in a fund that's directly tied to the Chinese markets is that you can take advantage of the strong Chinese currency. The fund is invested in companies with assets and earnings denominated in the yuan, and I believe the yuan will continue its steady appreciation of 3%–5% a year versus the U.S. dollar.

If you are a member of China Strategy and want to learn more about this fund, click here to sign in and read the entire discussion.

For more information about which China funds to buy now, visit my website at www.chinaprofitstrategy.com and become a member to gain instant access to my buy advice.