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How best to invest in slowing, but still growing, China

Thursday, November 1, 2012

Divining the state of the world's second-largest economy is not easy, but experts suspect the stall may be more severe than reported

PAUL BRENT
Special to The Globe and Mail

Will China have a hard or soft landing? Will future growth come from exports or from internal growth? These are the questions being asked by observers of China's economic growth.

For savvy investors, though, the bottom line is that the world's No. 2 economy will continue to be one of the growth engines and bright spots next year and beyond. While it has slowed down after decades of double-digit growth - official GDP growth is said to be 7.4 per cent in the third quarter - opportunities still abound.

So how does one play the slower-growth China story?

"ETFs [exchange-traded funds] in general offer a very easy way to get in and out of markets for North American investors," said Chris McHaney, vice-president and portfolio manager of Bank of Montreal Exchange Traded Funds.

Believing in the scenario that China has begun to shift from an export-led growth model to one more focused on bolstering its middle class and consumption generally, the bank points to its BMO China Equity ETF that offers exposure to large companies such as China Mobile, Web services firm Baidu Inc. and a mix of insurance, energy and telecom companies. It also offers an actively managed mutual fund (BMO Guardian Asian Growth and Income fund) that invests in companies outside of China that are likely to benefit from a domestic-led growth scenario.

Because official government growth numbers as well as those from Chinese companies are held with some suspicion, the Toronto-based Mr. McHaney recommends that investors stick with Asian-focused ETFs, mutual funds or North American-listed ADRs (American Depository Receipts), "which have the same regulatory requirements that any North American security would have that trades in Canada or the U.S." While official Chinese statistics are viewed with some skepticism, the country has raised its game when it comes to reporting on its economic situation, Mr. McHaney noted. "The government used to only release statistics annually, and they are doing a lot of things quarterly now, so there is a bit more meat behind the numbers and it is easier for outsiders to track, as well."

Canadian investors generally are still wary of betting on China's growth story. A Franklin Templeton Investments 2012 study found that only 10 per cent of Canadians expect to invest in Asia. At the same time, the survey found 38 per cent of Canadians believe that emerging Asian countries present the best investment opportunity over the next decade or so.

China has enjoyed hyper growth and development for the past 30 years or so because its command economy structure has allowed the government to dictate the pace of growth to a degree that would be unthinkable in the Western world or even much of the still-developing world. That same structure allowed it to inject massive fiscal stimulus into the economy during the international financial crisis and recession .

"We are certainly of the view that the policy makers in China are realizing that the slowdown has been more broad-based than anticipated initially and are prepared and willing to take action in order to slow down the deceleration and bring some stability to the economy," said Marc Cevey, chief executive of HSBC Global Asset Management (Canada) of Toronto.

Chinese government officials have plenty of buttons and levers to employ to keep growth chugging along. With one of the lowest debt-to-GDP ratios among Organization for Economic Development nations at around 18 per cent (or 45 per cent counting local and government debt, still less than half a typical developed country), it means it can once again flood its economy with stimulus.

"Clearly the central bank and the central government have realized that the measures it previously implemented to reduce speculation and investment have had their intended effect and, compounded with a drop in exports and consumption, have resulted in a slowdown that was more than anticipated," said HSBC's Mr. Cevey, who is a firm believer in a "soft landing" for the country.

Not everyone is sold on China's official 7.4-per-cent official growth rate or that it will painlessly make a transition from its successful export-led development model to one that relies on increasing consumer spending and internal economic growth.

Jurrien Timmer, the Boston-based director of the Canadian investor-focused Fidelity Investment's Tactical Strategies fund, looks at "on the ground" indicators, such as Taiwan exports (which mainly go to China), electricity production and the price of commodities, such as coal and iron ore, to divine the state of China's economy. He sees a less rosy picture.

"It suggests to me a growth rate of 3 to 5 per cent, rather than 7 to 8 per cent," he said. "I think the big question that investors need to ask is, is this slowdown that is clearly under way and has probably been more severe than the government will tell you, is it a cyclical slowdown or is the bloom just off the rose from a structural perspective?"

Switching from an export-led model to a consumption model - and keeping growth at 7 per cent - is likely more difficult to achieve than many believe, he said.

SPCL