Robert Hsu China Stock Strategy

Hello! Welcome to my new blog, China Stock Strategy. I’m Robert Hsu, and with this blog, I hope to help you profit from investing in China.

The economic emergence of China is the greatest boom the world has seen, and it’s the mother of all investment themes in this new century. Every major trend is either driven by China or, at minimum, heavily influenced by it. This is true for energy, commodities, technology, bonds -- even real estate.

As this land of one billion people modernizes and makes the leap to capitalism all at the same time, I believe we will profit from some of the best investing opportunities of our lifetimes.

This blog brings together two of things I have always been most passionate about: China and investing. I was born in Taiwan to Chinese parents, so China is in my blood -- literally. After I moved to America as an eight-year-old, I continued reading Chinese newspapers every day to keep up with developments in Taiwan, Hong Kong and China.

My interest in China grew as I got older, graduated from college and pursued my other passion -- making money in the financial markets. I traded a wide range of markets including stocks, bonds, commodities and currencies, eventually becoming a hedge fund portfolio manager at Wall Street powerhouse Goldman Sachs. There, I was fortunate to learn from some of the finest investors in the world. I amassed my first million by the time I turned 30, and in 2004, I started my own money management business called Absolute Return Capital Advisors. I also write two stock advisory newsletters, China Strategy and Asia Edge.

Now I want to help you build your own fortune by profiting from the China Miracle. In the weeks and months to come, I will take you on a tour through China’s investing and social landscapes, and together we will profit from the greatest economic transformation in the history of mankind.

China’s economic emergence -- the greatest economic boom in the history of the world -- is filled with both enormous opportunities and wealth-destroying hazards. My goal is to help you profit from the China Miracle, and to do that successfully, you need to know both the right areas to invest in as well as the dangers to avoid.

That’s why I want to share with you some general rules of thumb to keep in mind when you invest in China. Here are some of the most important things that China investors should know:

1. Avoid most state-owned enterprises. State-owned enterprises (or SOEs) are exactly what they sound like: corporations owned by the Chinese government, many of which are publicly-traded. They still make up the majority of China’s largest businesses. However, government ownership for most of them is a liability.

Bloated government-run organizations like SOEs don’t stand a chance when competing against the much more effective private businesses run by entrepreneurs who have a burning desire to succeed. That’s why most SOEs generally make terrible investments.

Notice I said “most.” There is one exception when it comes to investing in SOEs: enterprises with government monopolies in major growth industries that still control their markets, such as energy and telecommunications. These monopolies are like licenses to print money, and investing in the right ones can be very profitable. I will talk more about these in future blog postings.

2. Just say no to China mutual funds. Mutual funds are the choice investment for many people. Some feel comfortable with the relative simplicity of mutual funds, having a manager (or an index) guide their investments and knowing that they are diversified.

I need to warn you, though, that most of the time, mutual funds are not the most effective way to make your money from China’s growth. Chinese mutual funds tend to invest too much in SOEs, and as we just talked about, that can be dangerous. China mutual funds also do a poor job of managing risk. Successfully profiting from China’s growth requires effective risk management. Most mutual funds simply do not know how to sell, and the resulting losses can be substantial. And lastly, most Chinese mutual funds focus too narrowly on Chinese companies. The China Miracle is a worldwide phenomenon, so you’re hurting your returns if you only limit yourself to Chinese companies.

3. Don’t get taken for a ride by Chinese automakers. China’s auto industry is fascinating. Imagine the fourth-largest car market in the world, a giant economy growing at nearly 10% a year with over 100 million middle class consumers and a new highway system stretching over 40,000 miles long.

Given all of this, investing in China’s car industry seems to be a no-brainer, right? Not necessarily. Like many things in China, what seems obvious on the surface is often not true when you know the real story.

While some of the growth numbers look appealing to the uninitiated, the truth is that you should not invest in China’s auto industry. The first and most important reason is that there are just too many car companies there. Although demand for new cars is strong, there are more than 100 car companies in China!

Also, China’s domestic auto industry is heavily protected and simply not globally competitive. In order for a foreign company to set up production in China, it needs a 50% local joint-venture partner -- most often an SOE of some sort. The only exception has been Honda Motors, which is well-respected in China and allowed to own 65% of its made-for-export car factories.

4. Avoid stocks listed in Mainland China. There has been lots of media coverage lately about the red-hot exchanges in China. In fact, the Shanghai market was one of the best-performing stock markets in the world last year! But it’s a dangerous place to invest, and here’s why:

• Stocks in China sport very high valuations
• There are too many stocks available
• The listed companies tend to be of poor quality

None of these three issues will be resolved anytime soon, so you should stay away from companies traded on the Shanghai and Shenzhen exchanges. The best Chinese stocks are those listed on exchanges outside of Mainland China.

Many of you have probably heard the old Wall Street expression "sell in May and go away," which refers to traders who sell their positions and go on vacation for the summer. Well, that saying is certainly not true in China! The markets there have been blistering hot, and even though the year is not quite half finished, stocks there are up an impressive 50% year-to-date.

To slow the scorching Chinese markets, the government in Beijing recently began an important initiative. On Friday, May 11, China made a big announcement: Chinese banks can start investing in foreign stocks. This is huge news because up until recently, banks had only been allowed to invest in the domestic markets in Shanghai and Shenzhen.

The new ruling is called the Qualified Domestic Institutional Investors Program, or QDII for short. Basically, the QDII lets Chinese banks set up new professionally managed funds containing foreign-listed stocks. This marks the first time ever that Chinese investors will be allowed to purchase overseas stocks through bank-managed mutual funds.

Since the QDII only affects Hong Kong-listed companies right now, the impact of the program is more symbolic than substantial. But this is an important first step for China -- it finally gives its citizens access to foreign stock investments. I expect this trend of financial freedom to continue, and for high-quality U.S.-listed Chinese companies will benefit in the months ahead.

This is a topic I expect to talk a lot about as new developments arise and specific investment opportunities make themselves available.

In my last post I mentioned that I expected to talk a fair amount more on QDII in the future. I didn't quite expect to get another announcement only a week later.

More news has come out of China about the QDII program, and it should translate into big profits for Chinastocks.

As you may remember, last month China took an important step towards opening its financial markets with a new ruling called the Qualified Domestic Institutional Investors Program (or QDII for short). Under this program, domestic banks in China were allowed to start investing in foreign stocks. (In the past, banks had always been limited to purchasing foreign bonds.)

This was good news for Chinese investors because it meant they would finally be able to go to their banks and buy professionally managed funds containing foreign-listed companies.

Still, the only major stock regulatory agency in the world that has signed an agreement with China's Banking Regulatory Commission is Hong Kong. That means new QDII funds will only be allowed to invest in Hong Kong-listed stocks. It's still uncertain as to whether or not other countries will sign up for the QDII. Until that happens, Chinese investors will still have limited access to international securities and demand for investment alternatives will continue to build.

But China took another step last week towards expanding its QDII program. Chinese securities regulators announced that they will now allow brokerage firms, fund managers and insurance companies (not just banks) to use foreign shares to set up new mutual funds for Chinese citizens.

At the moment, brokers, fund managers and insurance companies are limited to investing in Hong Kong stocks, but now Chinese investors will have even more fund options to choose from.

Though it will still take some time for banks, insurance companies and brokers to set up all of the back-end processes that will get these new funds to the public, the psychological impact of this new policy will be enough to push stocks higher in the coming months.

Experts believe that Chinese investors could buy as much as $100 billion in foreign funds once all of the systems are in place. It's hard to imagine, but this plan is actually designed to cool the Chinese markets and allow them to grow at a more reasonable pace. I don't think the new policy will have the desired effect, because there is still already enough momentum in the Chinese market to hold investors attention and keep them buying.

But, I do believe that those Chinese companies that are also listed in Hong Kong will benefit the most from this new twist to QDII. I expect most institutional investors to create funds with well-known Mainland Chinese companies listed in Hong Kong, some of my favorites are China Life (NYSE: LFC), China Mobile (NYSE: CHL) and Huaneng Power (NYSE: HNP).

I'll continue to keep an eye on the developing QDII situation in China, and I'll be sure to let you know if I hear of more exciting news that could benefit U.S. holders of Chinese stocks.