By JACK HOUGH
China's economy has swelled four times in size in a decade, but growth is slowing. Market forecasters are locked in a debate over what comes next.
Bears expect falling property prices, souring loans and a hard landing for an economy that is heavily exposed to construction. Bulls say China will manage a softer transition to growth that is slower but not slow, as purchases by its middle class consumers play a more prominent role.
Deciding whom to side with is devilishly difficult. But much of the fear might already be priced into China's shares, says John De Clue, head of U.S. Bank's global strategies group. The iShares FTSE China 25 Index Fund (FXI),
China's economic importance is such that ambivalent long-term stock investors should move beyond the question of whether to invest and focus instead on how much, and how.
China contributed 9.3% of world economic output last year, according to World Bank data, and its economy grew at an annualized pace of 9.1% in the third quarter. It was China's slowest growth in two years, but it compares with just 2% in the U.S.
"I see big institutional portfolios with 1% in China and 3% in France, even though China's economy is twice as large," says Kevin Carter, chief executive of Baochuan Capital Management, a China hedge-fund firm. "It doesn't make sense."
If 1% is too little, U.S. investors who wish to stay neutral on China might find that a 9% or 10% stake, although in line with China's economic size, is too much. That is because multinational firms in, say, a Standard & Poor's 500-stock index fund offer China exposure in terms of the revenues they collect there.
It is impossible to know a U.S. index's precise China exposure, because companies break out revenues in different ways. Asia as a whole made up 5.2% of S&P 500 revenues in 2009, according to a Morgan Stanley (MS)
Suppose an investor decides to add a 5% China position to his stock portfolio. The next decision is how.
The Market Vectors China (PEK)
Some Chinese companies are listed on U.S. exchanges -- but they are a mixed bag, says David Semple, director of international equity at Van Eck Global.
While some are looking to cater to U.S. investor demand, others have been racked by accounting scandals. As a result, demand is hurting even for shares of the reputable Chinese firms with U.S. listings. Diversification via a mutual fund can help, but only to a point. The PowerShares Golden Dragon Halter USX China Portfolio, which focuses on U.S.-listed stocks, is down 26% this year.
There are several China index funds that hold shares traded in Hong Kong, but some weight companies by market value. That can produce lopsided portfolios. The largest firms are closely tied to the recent construction boom, says U.S. Bank's Mr. De Clue. Companies in the financial, energy and basic-materials sectors have a 79% weighting in the iShares FTSE China 25 fund.
AlphaShares, a China index specialist founded by Baochuan's Mr. Carter and Princeton economist Burton Malkiel, puts limits on sector concentration. The Guggenhaim China All-Cap (YAO)
Another, safer option is simply to buy shares of U.S. firms with revenue exposure to China. Mr. Carter likes Yum Brands (YUM),
China shares are a good deal now, Mr. De Clue says -- but don't expect fast gains. Valuations in China "are very low," he says, "but stocks can stay cheap for a long time."—Jack Hough is a columnist at SmartMoney.com. Email: email@example.com