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Investors Should Accept China's Emergence

14/02/2014|Timothy McCarthy|  US News and World Report

This year, reluctant investors should begin to put at least a little China exposure into their long-term investment portfolio.

“Why should I dare? I still read about terrible things happening in China," you may say. "The pollution is unbearable. I can’t trust their accounting. And isn’t their banking sector a mess?  All I hear about is their corruption and I certainly don’t trust the political situation. What if there is a global emerging markets crash? Shouldn’t I wait?”

Indeed, if you read the average article written about China over the last 20 years, many American and European pundits have predicted that China is going to melt down in the next year. And now is no different. In fact, if you added up all the dire predictions made since 2000, when China’s percentage of global gross domestic product (adjusted for purchasing power parity) was just above 5 percent, you would assume that today it would not be much higher. Or you would concede that they have grown, but to only 8 to 10 percent, given all its well-publicized problems. Yet, China has grown to 15 percent of the world’s GDP.
Smarter Investor chart

Why has the Western world been wrong about China for so many years?
1. Mixing your political and emotional views with your investments isn’t smart. One Hong Kong billionaire I managed money for said it best, when he said, “Most people don’t separate their investment strategy from their emotions. I say, 'Even when I cannot agree with your politics and may not even like you personally, if I think you are a good investment, I am still putting some money behind you.'"
2. Remember our own country’s history. I find it alarming how many people compare China today to America today. Yet the countries are at entirely different stages of development. Rather, we should remember what America looked and acted like after we recently emerged and were becoming interesting from a serious core investment standpoint, and when we made investors the most return. Toward the end of the 19th century, America looked quite similar to China. Pollution was horrid and some may argue that corruption was even worse than China's. And forget social stability. Why do you think the Europeans called much of our country the Wild West(野蠻的西方)? Europeans had many reasons not to invest in their wild young brethren to the west. Yet, many of the European investors who recognized the economic and financial opportunities at that time profited quite well.
Still, you may ask, “What makes China so compelling that I should have any exposure in my portfolio?”
1. China has become the largest capitalist population in the world. Ever since Deng Xiaoping is said to have uttered the phrase, “It doesn’t matter if a cat is black or white, so long as it catches mice,” China has been on the road to a more free market economy. It has been so successful that China now owns more than $1.4 trillion of our Treasury bonds. Indeed, like it or not, they are America’s biggest lender. But it is not all bad news that they have become so rich and have even more millionaires in the Central Committee of the Communist Party than we have in our Congress. Remember the expression, “Lend me a little money and you are my creditor, but lend me a lot of money, and now you are my partner.” China and the U.S. are now like conjoined twins connected at the wallet. 
2. China remains a major global growth engine. There are so many high-growth companies in a myriad of industries, that to leave out China is to throw away too many growth opportunities for your portfolio. Sure, some will fail and inevitably, there will be volatile times, just as in the U.S. But you have to put what you read in the Western news media into context, and not miss these opportunities. Studies independent of Chinese influence now estimate that China’s problem loans in 2014 could rise to approximately 1.5% of total loans up from less than 1% in 2013 (e.g. per recent Barclays and UBS reports). Admittedly, some estimates are that the real number is even higher and this percentage could rise further in 2015, but we are not looking at levels that would permanently derail their economy. Though there could be short term volatility, we have never seen a country collapse with such a large net reserve. 
And have we ever seen a country collapse with such a large net reserve? But some investors may worry over the dire predictions that China’s growth is on the decline. Even the most pessimistic of pundits believe that during 2014, China could fall to an annual rate approaching 7 percent growth per year. All of the developed countries would love to have a 7 percent growth rate – more than double the U.S.
3. Western investment management company expertise. Unlike in previous decades, the average retail American investor now has direct access to mutual funds from companies with considerable local expertise. There are dozens of American and British asset managers with boots on the ground permanently in China. They are on site reviewing the accounting and other business factors in each company before they buy. They separate the “wheat from the chaff” for you. The upshot is that for as little as $3,000 to $5,000, a retail investor can buy a fund or an exchange traded-fund from a variety of highly competent and trusted western fund managers to garner Chinese exposure.
4. An excellent way to diversify your overall risk. We all know that it is critical to have a broadly diversified investment portfolio. Fortunately, there are many periods in the economic and financial cycles, especially over time where the Chinese and the U.S. stock and bond markets diverge. Thus, having even a small allocation in your portfolio of countries like China will lead to decreasing your risk while increasing your long-term return.

But what about the headlines this past month? Isn’t China about to go into a major recession? Of course, China, like the U.S., will periodically experience recessions and big market corrections. But that’s why “trickle investing” works so well. The safest way to increase your exposure is to do it slowly, e.g. buying just a little each quarter or annually over a period of years. That way, since it’s impossible to predict short term market volatility, you can’t get too hurt as you will be buying a little each time in both up years and down years. In the long term, you will catch the growth of the market and your average price will be smoothed out over the years.
In closing, there is no excuse to delay making this year, the Year of the Horse, your year to begin to trickle in at least a small portion of your total investment portfolio into Chinese exposure.


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