As the rest of the world dumps Chinese stocks, some wade in

January 28, 2016

“With a volatile market like China, buy it when the world hates it and sell when no one’s worried,” says Jim Oberweis, who runs the Oberweis China Opportunities fund. “That’s worked pretty well over the last 20 years in China, and now sure seems to me like a period where everyone hates it.”

Only time will tell if he and other Chinese stock fund managers are right. They could have made the same argument after each of the Chinese market’s many sell-offs the last five years, and it wouldn’t have netted them much, if anything.

The MSCI China index has had seven declines of at least 10 percent over the last five years, including the 19 percent tumble since late October, which itself followed a 34 percent plunge from April into September by just weeks. After all those ups and downs, the MSCI China index has lost 12 percent over the last five years and is close to its lowest level since the summer of 2009.

That’s why fund managers say an investment in Chinese stocks will require lots of patience, maybe even a decade. Oberweis’ fund, for example, has lost 15.9 percent over the last year, even though it’s been one of the top performers in its category. But over the past 10 years, it’s returned an annualized 8.9 percent, better than the S&P 500′s 6.1 percent annual return.

WHAT’S CAUSING THE PANIC

China’s economy grew last year at its slowest pace in a quarter century, and economists expect it to slow even more this year. Part of that is by design. The Chinese government is steering the economy toward consumer spending and away from exports and investments in infrastructure. It hopes that will yield a more sustainable, though slower, rate of growth.

The government is also pushing anti-corruption measures and efforts to make the country’s huge state-owned banks and telecom communications companies more efficient.

The goal is to try to slow growth without stopping it. The worry is that the government will lose control of the slowdown, and the economy will fall hard.

“It’s painful at the moment, and there could be some more pain to come,” says Jasmine Huang, manager of the Columbia Greater China fund. “Eventually it will be good for the economy.”

Huang is avoiding companies from what’s known as “Old China” and owns no raw-material producers and few companies in the industrial and energy sectors. But instead of hiding out in cash, she has been investing in “New China.” She has been focusing on e-commerce companies, where she expects revenue to grow even if the overall economy stumbles because more Chinese shoppers are going online.

She also sees big growth for health care companies. They make up only about 2 percent of the MSCI China index, and she says they could grow to become the 10 or 20 percent of the market that health care represents in developed markets.

WHY THIS DECLINE IS DIFFERENT

Andrew Mattock, lead manager at the Matthews China fund, understands if investors are feeling gun-shy about Chinese stocks. “For five years now, if you’ve made money, it’s been hard to get, and you’ve lost it quickly in these sell-offs,” he says.

But the most recent drops for Chinese stocks have brought them close to their cheapest level since the financial crisis, relative to their earnings. The MSCI China index was recently trading at about 8.5 times its expected earnings per share over the next 12 months. That’s down from a price-earnings ratio of nearly 10 at the start of the year and approaching the 6.8 ratio of 2008.

Mattock, like Huang, has steered his fund toward stocks that he sees profiting from China’s shift toward consumer spending. His top holdings at the start of the year included Tencent, which operates the popular WeChat social media service, and JD.com, one of China’s largest e-commerce sites.

“This time, I think, is different because there’s actually change going on now,” Mattock says of the economic reforms underway in China. “There are doubts about whether they can do it, but what they’re trying to do is positive.”