Why and how to invest on the Shanghai stock exchange - the WTO column

I'm helping a few investors to invest some rather smallish funds on the Shanghai stock exchange, as a kind of test of my knowledge of the market. The preparations are already running for some time, and because of the massive upheaval the China stock markets have been causing, it seemed a good idea to share a bit about the backgrounds for an outlandish audience. For most of you, who do not have the Chinese nationality, it is impossible to invest in those so-called A-shares, but that might change in the future, so getting some sense of orientation is not bad.

On Monday in a first move we invested 230,000 renminbi (€ 23,000) in a mutual fund. From the start it was clear we had to go for a mutual fund. Following the stock exchange fulltime was no option for my investors and not for their humble advisor. The stock market is just like the internet: it is good to know what is going on, but you do need a life next to that.

A few figures about the performance of the mutual funds over 2006 from the China Daily:

Fifty-three mutual funds in China reported operating profits of 49.96 billion yuan (6.46 billion U.S. dollars) in 2006, thanks to the country's bull markets. Their net incomes totaled 22.28 billion yuan, while paper profits reached 27.69 billion yuan, according to the annual reports of 53 mutual funds that launched by ten fund management firms.

The record operating profits were seven times greater than the seven billion yuan earned in 2005 by all 206 mutual funds under 46 fund management companies in China.

For the investment we needed to go find a new fund, and when I say new, I really mean new. There are some financial institutes that have pretty new funds and an excellent reputation, like the China International Fund Management, partly owned by J.P. Morgan Fleming, and the E-fund Management. But you cannot wait until those funds have a bit of a track record. Since their value goes up pretty fast, you are losing money when you do not join the day a fund opened. In the end we picked the China Merchant Fund. They launched a new fund on Monday 26 March at midnight, and so we called in a few minutes after midnight. The reputation of their team was not as excellent as the other two I mentioned, but it was still ok and we expect our early move will outweigh that difference.

The Tuesday dip in the Chinese and later the international stock markets earlier this year has put many stock experts outside China on the wrong leg. Wrongly they suggested that the Tuesday dip - still marginal compared to the upswing of 2006 - was a signal that the market would collapse. Some even thought it was a signal the economy as a whole was in trouble. There are two reasons why you should be suspicious about such a connection. First, foreign analysts seem unable to make a living without predicting the demise of China. There are two reasons for them to worry, since China is now going to collapse and even books about the issue do not sell, friends in the publishing business tell me. You cannot make a living anymore in predicting the end of China or the one-party system.

Second, the government is a much more important player in the economy than most foreign analysts assume. There are basic financial reasons for that. About two-third of the shares of state-owned companies, worth a US$250 billion, are in the hands of the government. What is happening to those shares is much more important for the confidence in the Chinese stock markets than any financial weather forecast.

When a study at the beginning of this century suggested the government should get rid of those non-tradable shares, the shares came in a free fall. Then, for years, even official denials of the sell-off caused new plunges, since nobody believed those statements. Otherwise companies and the economy can develop almost any problem, the investors do not care. Now, after last year the half-decade movement south ended, because investors believed the government would do things right this time. On top of that, much more capital is available to soak up those funds.

Maybe in ten years time, when all those shares in the hands of government departments are really sold on the market, the stock market might work like it does in the rest of the world: an an indicator for the stability of the economy.

Fons Tuinstra

(this is a rewrite for Chinabiz of some pieces I published before on my weblog ).