Contrarian Investing – Investing in China

In recent times, there has been a lot of talk about Global Investing with all kinds of narratives spun around to make it sound that if you are not investing globally you are missing out. Nothing could be further than the truth, but selling expensive products requires a good narrative and right now with US markets providing market-beating returns, a good excuse is all that is required.

Why to invest globally vs locally. The first time I heard about Global Investing was from experts in the United States. The United States, they said, being a mature country will grow around 3% while emerging giants such as China and India are growing close to double digits. Why confine to the United States alone they argued.

Over the last decade and more, anyone who followed their advice and invested in emerging nations underperformed the S&P 500. Diversification is good but mindless diversification adds no value.

In India, at last count, there are 56 Mutual Fund Schemes offering various themes and a few countries with 5 new offerings. But if one were to look at the Assets under Management, 5 funds and one fund of fund, all focussed on the US markets.

Axis and Kotak have global innovation funds but where majority of the underlying stocks are from US (65% and 80% respectively). A key attraction for investors has been the recent strong trends one has observed in the US markets.

But the same US markets saw a near 12 year period of Zero return between 2000 and 2011. Nasdaq was able to break above the high of 2000 only in 2016. In the same period of time, Indian Markets did phenomenally well.

Post the recent attack on Indian Troops, China evokes a very different sentiment than one we had before that. This is not limited to India alone as we have seen a severe spike in China being seen as unfavorable across much of the developed world.

Much of this is a result of not just trade disputes China has with others or the fact that CoronaVirus started out there but the aggressive Wolf Warrior Diplomacy that has been carried out with Ambassadors all but threatening the leaders of other nations for what China sees as errors of Omission or Commission. 

The biggest risk of investing in Autocratic countries is that they lack the rule of the law which allows for fair competition and pricing. This in a way pushes away prospective investors. This also means that such countries are generally cheap. They are of course cheap for the reason that your companies can get booted out of business without any compensation.

Take a look at the Cyclically Adjusted PE Ratio of major indices (end June 2021)

Anyone who has read Red Notice: A True Story of High Finance, Murder, and One Man’s Fight for Justice by Bill Browder knows how risky it can be to invest in such a country. While I loved reading the book, I did wonder, is there another side to the story? The problem for autocratic countries is that their Judiciary is seen as one sided, even if there is another side to the story, we may tend to not believe the same.

Countries such as China & Japan have a conviction rate of 99%. A very high conviction rate either means that the police is extremely efficient or the judiciary is compromised not to challenge the state. Either way, it’s an extremely risky proposition to invest in such countries directly.

China tech crackdown is India’s gain was a recent article pointing out how in this year, Venture capital funds have shifted funds to India due to the duress they are observing in China post the Alibaba incident. 

Excess returns are not possible by investing into companies or countries where everything is working out great. Decent returns, Yes but not Excess returns. Excess returns is the fee that the market pays the risk taker for buying something when no one wants. Value Investing 101 is all about investing in what everyone seems to think as risky. Markets are right a lot of times with risky companies going down the tube. But they are also wrong and that is where the opportunity lies.

Currently I am starting to see China as one such country which is out of favor, seems to carry risks that are opaque in nature but can blow up spectacularly and a country that is said to have peaked early.

Investing in China for outsiders is tough. This is a reason why Hong Kong for long has been the gateway for investing in China. In 2010, when there was little talk of International Investing, the Benchmark Asset Management Company brought out a HangSeng ETF. Motilal Oswal followed up with the N100 the very next year.

When compared with one another, the returns can be said to be Chalk & Cheese. The Nasdaq 100 ETF since its listing has delivered an absolute return of 884% vs 162% for the HangSeng Bees. Not surprisingly the Hang Seng Bees has a very small asset under management – just 100 Crores.

While Nasdaq has been an outperformer for a long time, the Assets themselves are fairly recent. As of end October 2019, the N100 ETF had an AUM of 242 Crores and its Fund of Fund an AUM of 98 Crores. Today (end October 2021), the AUM of the ETF is 5,703 Crores and the AUM for the FOF stands at 3,998 Crores.

The highest risk in investing is not going with the crowd but going with them when they are wrong which usually happens at peaks and bottoms. The best tech companies are no doubt in the United States, but when it comes to valuations, how many are priced to perfection and what happens if those predictions fail to come true.

When an asset management company starts a new fund, the general reasoning is that they are getting into the asset gathering mode. But what if a fund launches a fund that may not really get its asset base to swell. The launch of the Mirae Asset Hang Seng TECH ETF to be suggests that rather than it being another attempt to boost their assets (which crossed the magical figure of 10 Lakh Crore a few months ago), this is a attempt to provide a opportunity to invest in a market that is cheap, seems to have a decent future with a affordable product.

Another interesting NFO that is coming out is the Nippon India Taiwan Equity Fund. While much of Taiwan’s market is China, it’s tough to know how they can play out if China decides to start squeezing Taiwan economically. 

One of the reasons to avoid International country specific funds is we really know so little about them. Seven years ago if you had invested in the Franklin India Feeder – Templeton European Opportunities Fund, the value of investment would have grown by an awesomely obscene CAGR of 2.20%. This even as Europe has recovered from the crisis that was seen as the end of the European dream. Anyone remember the PIIGS and the doomsday that was pointed out then?

Investing as a whole is always risky. All we can do is attempt to address the risks as efficiently as we can while also hoping that our thesis is not extraordinarily wrong.