Burton Malkiel suggests boosting China exposure
The author of A Random Walk Down Wall Street says there's no random walk down Nanjing Lu, and suggests combining direct and indirect investments to achieve more profitable and less risky returns from China over the long run.
Employing a mixed strategy of investing directly in China shares and global companies with business links to the mainland is the best way to profit from that market, according to Burton Malkiel, a professor of economics at Princeton University who is best known for his book, A Random Walk Down Wall Street.
His latest book is From Wall Street to the Great Wall: Investment Strategies to Profit from ChinaÆs Booming Economy, but it's not just a repeat of his famous efficient-markets investment ethos that became a cornerstone of the index investment industry in the United States.
ôAn indirect strategy, coupled with direct investing, is a much lower risk way of investing in China,ö Malkiel told regional institutional investors attending AsianInvestorÆs third Annual Asian Investment Summit, held yesterday and today in Hong Kong.
Malkiel, who is also the chief investment officer of US-based and China-focused investment management firm Alphashares, says that while investors are normally warned that past performance isnÆt an indicator of future performance, thereÆs some merit to be taken from the historical success of this mixed strategy. His calculations show that the mixed strategy outperformed the S&P500, the MSCI EAFE (Europe, Australasia and the Far East), the S&P Global 1200, and the FTSE Xinhua China 25 indices in the period between January 2002 and March 2008.
Investing only in Chinese companies listed in the mainland, Hong Kong, Singapore, New York or other markets wonÆt provide investors with the full benefits of ChinaÆs continued economic growth, Malkiel says. The number of Chinese companies and their combined market weights simply isnÆt enough to provide the exposure investors need, he adds.
At present, ChinaÆs economy makes up around 5% of the worldÆs gross domestic product output û a percentage thatÆs even higher when purchasing power is considered. And yet, Chinese shares make up only around 1% to 1.5% of global equities indices. ThatÆs a disconnect Malkiel highlights as one of the best justifications for a mixed strategy.
ôMost investors are underexposed to China,ö Malkiel says. ôI donÆt see why anyone should have less than the equivalent of ChinaÆs GDP weighting in that market.ö That suggests investors should have a 10% weighting to China, on the basis of purchasing power parity.
The choices are vast and varied, when it comes to global companies with business links to China. Malkiel cites Yum! Brands, Las Vegas Sands, LVMH Moet Hennessy Louis Vuitton, Nike, Rio Tinto, and BHP Billiton as examples.
Yum! Brands owns, operates, and franchises the worldÆs largest network of restaurants, with outlets including Kentucky Fried Chicken, Taco Bell, and Pizza Hut. Malkiel notes that Yum! Brands isnÆt doing particularly well in the US, with disappointing same-store sales figures. The company has managed to post a 20% growth in earnings, however, mainly due to its operations in China. The company is opening many KFC stores in China and owns a chain of Chinese-style fast food restaurants there, he says.
Las Vegas Sands is expected to continue to get a huge boost from its operations in Macau, which is already outpacing Las Vegas in terms of gaming revenues. Louis Vuitton, meanwhile, is selling more handbags in China than any other market in the world, Malkiel says.
ChinaÆs economic growth is bound to slow down, Malkiel notes, but it will continue to expand at a stronger pace than developed markets for at least 10 more years. In 20 years, China will be the largest economy in the world, he says.
While valuations of China-related shares are far from being cheap, they are at least more benign and provide a ôfar better entry pointö compared with around six months ago, Malkiel says.
A Random Walk Down Wall Street has played an important role in encouraging institutional and individual investors to use index funds, but that's not something Malkiel would suggest for China-listed shares.
"Indexing won't work in the China A-shares market," he says. Among his reasons: many funds have consistently beaten the benchmark indices in China and the law of "one price" has been violated with the multiple listings of shares in various markets.
He does advance the case for real estate investments in China, which he says would make a good hedge against rising inflation. He notes the economy's strong fundamentals, continuing infrastructure development, increasing urbanisation, and the development of the central and western regions of the country.
Malkiel stresses, however, that investing in China, and in any other market, involves risks no matter what investment strategy is taken.
Macro risks include: on-again and off-again tensions with Taiwan and Japan; environmental degradation; uneven income distribution; corruption; and the weak banking system. Malkiel notes, however, that these issues are being addressed.
"There are plenty of risks, but there has been progress in addressing all of these risks," he says. "They won't derail China's growth."
His latest book is From Wall Street to the Great Wall: Investment Strategies to Profit from ChinaÆs Booming Economy, but it's not just a repeat of his famous efficient-markets investment ethos that became a cornerstone of the index investment industry in the United States.
ôAn indirect strategy, coupled with direct investing, is a much lower risk way of investing in China,ö Malkiel told regional institutional investors attending AsianInvestorÆs third Annual Asian Investment Summit, held yesterday and today in Hong Kong.
Malkiel, who is also the chief investment officer of US-based and China-focused investment management firm Alphashares, says that while investors are normally warned that past performance isnÆt an indicator of future performance, thereÆs some merit to be taken from the historical success of this mixed strategy. His calculations show that the mixed strategy outperformed the S&P500, the MSCI EAFE (Europe, Australasia and the Far East), the S&P Global 1200, and the FTSE Xinhua China 25 indices in the period between January 2002 and March 2008.
Investing only in Chinese companies listed in the mainland, Hong Kong, Singapore, New York or other markets wonÆt provide investors with the full benefits of ChinaÆs continued economic growth, Malkiel says. The number of Chinese companies and their combined market weights simply isnÆt enough to provide the exposure investors need, he adds.
At present, ChinaÆs economy makes up around 5% of the worldÆs gross domestic product output û a percentage thatÆs even higher when purchasing power is considered. And yet, Chinese shares make up only around 1% to 1.5% of global equities indices. ThatÆs a disconnect Malkiel highlights as one of the best justifications for a mixed strategy.
ôMost investors are underexposed to China,ö Malkiel says. ôI donÆt see why anyone should have less than the equivalent of ChinaÆs GDP weighting in that market.ö That suggests investors should have a 10% weighting to China, on the basis of purchasing power parity.
The choices are vast and varied, when it comes to global companies with business links to China. Malkiel cites Yum! Brands, Las Vegas Sands, LVMH Moet Hennessy Louis Vuitton, Nike, Rio Tinto, and BHP Billiton as examples.
Yum! Brands owns, operates, and franchises the worldÆs largest network of restaurants, with outlets including Kentucky Fried Chicken, Taco Bell, and Pizza Hut. Malkiel notes that Yum! Brands isnÆt doing particularly well in the US, with disappointing same-store sales figures. The company has managed to post a 20% growth in earnings, however, mainly due to its operations in China. The company is opening many KFC stores in China and owns a chain of Chinese-style fast food restaurants there, he says.
Las Vegas Sands is expected to continue to get a huge boost from its operations in Macau, which is already outpacing Las Vegas in terms of gaming revenues. Louis Vuitton, meanwhile, is selling more handbags in China than any other market in the world, Malkiel says.
ChinaÆs economic growth is bound to slow down, Malkiel notes, but it will continue to expand at a stronger pace than developed markets for at least 10 more years. In 20 years, China will be the largest economy in the world, he says.
While valuations of China-related shares are far from being cheap, they are at least more benign and provide a ôfar better entry pointö compared with around six months ago, Malkiel says.
A Random Walk Down Wall Street has played an important role in encouraging institutional and individual investors to use index funds, but that's not something Malkiel would suggest for China-listed shares.
"Indexing won't work in the China A-shares market," he says. Among his reasons: many funds have consistently beaten the benchmark indices in China and the law of "one price" has been violated with the multiple listings of shares in various markets.
He does advance the case for real estate investments in China, which he says would make a good hedge against rising inflation. He notes the economy's strong fundamentals, continuing infrastructure development, increasing urbanisation, and the development of the central and western regions of the country.
Malkiel stresses, however, that investing in China, and in any other market, involves risks no matter what investment strategy is taken.
Macro risks include: on-again and off-again tensions with Taiwan and Japan; environmental degradation; uneven income distribution; corruption; and the weak banking system. Malkiel notes, however, that these issues are being addressed.
"There are plenty of risks, but there has been progress in addressing all of these risks," he says. "They won't derail China's growth."
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