How to Get Rich in China Without Chinese Stocks

by Carl Delfeld

How to Get Rich in China Without Chinese Stocks

by Carl Delfeld, Investment U Senior Analyst

Thursday, September 22, 2011: Issue #1606

Do not fear going forward slowly; fear only to stand still.

- Chinese Proverb

China is one country where 10-percent economic growth in a given year doesn't necessarily lead to a strong stock market. As an investor in the Asian markets since the 1980s, I have learned this lesson the hard way.

Sure. A loss of capital is worse than a loss of opportunity. But it's a mistake to just sit there and do nothing. Especially since the Shanghai Composite Index has gone from 6,100 to 2,500 and is trading at single-digit valuations. Looks like the base for another bull market looking for liftoff.

Although many are bullish long term on Chinese growth, they're uncomfortable right now (with good reasons) investing directly in Chinese companies. So what's an investor to do…

Well, first you need to realize that a country's growth is distinct from its markets. But if you're looking to capture that growth, it's probably best to do so by avoiding highly speculative stocks.

Why not tap into Chinese economic growth through a couple of proxies that have democratic political systems and well-regulated, transparent markets that are chock-full of private companies with China at the heart of their growth strategies?

China Proxy #1 – The Biggest Investor in China

Let's start with a place that knows China better than any other - the Republic of China - better known as Taiwan.

When I spend a lazy Sunday afternoon walking through its capital of Taipei, I always pause at the many monuments dedicated to the nationalist leaders who fled from the mainland to Taiwan in 1949.

The tables sure have turned.

Taiwan has become the world's biggest investor in China, with 42 percent of its exports also headed to the mainland.

With a youngish population of 25 million, Taiwan enjoys a highly educated workforce producing a solid middle-income per capita GDP of about US$20,000.

While renowned for its tech prowess, with most investors thinking of Taiwan Semiconductor, its economy is largely led by vibrant small- and medium-sized enterprises.

But rather than chase market share and growth at all costs like many Chinese, Japanese, or South Korean giants, Taiwanese firms are acutely focused on profitability and shareholder returns.

The Taipei government, which signed a trade deal with the mainland last year, is also relaxing its restrictions on Taiwanese investing in China. Evidence of this is the approval last December for leading flat panel manufacturer AU Optronics to invest $3 billion in China.

In addition, Taiwanese entrepreneurs almost always look beyond their home base in crafting and executing their business plans.

While we're watching Starbucks' expansion plans for China, insiders keep an eye on Taiwanese competitor 85C (the temperature of a perfect cup of coffee), which now has more shops in Taiwan than Starbucks and is listed on the Taiwanese stock exchange. You might not like its squid ink buns, but you will like its plans to expand from its current 150 shops in China to 1,000.

I love 85C Founder Wu Cheng-Hsueh's motto of "be flexible, be fast" and the importance of having the courage to admit mistakes and limit losses, as he outlined in a recent interview with the Financial Times.

Get a slice of Taiwan in your portfolio, but keep in mind that it's an aggressive pick due to the periodic flare-ups between China and Taiwan. There will be a Taiwanese presidential election in January and the Chinese Communist party is preparing to pick a new generation of leaders next year.

China Proxy #2 – Quality, Balanced, Conservative Growth

Next let's balance dynamic Taiwan with the more conservative and high-growth Singapore. With a diverse population led by ethnic Chinese, Singapore lies at the heart of the booming Southeast Asian region between China and India.

This very livable city-state benefits greatly from its role as the world's busiest port and strategic location at the pivot and choke point of trade flows in the Asia-Pacific region. As China trade grows, so does Singapore. Its well-earned, high-quality reputation and balanced economy make it a great proxy for China's growth. Bilateral trade between China and Singapore jumped 25 percent in 2010, with China the top overseas investment destination for Singapore companies.

Singapore has a reputation as an efficient but slightly overbearing government, but this does not square with its top personal and corporate income tax rate of 22 percent, headed for 20 percent. Singapore also offers one of the world's highest real growth rates, a trade surplus and very low public debt, all of which leads to a strengthening Singapore dollar. What else could an investor ask for?

To execute your own conservative China strategy, look first at the iShares MSCI Singapore Index (NYSE: EWS) and iShares MSCI Taiwan Index (NYSE: EWT) exchange-traded funds. Surprisingly, there are no Singapore stocks that trade on the NYSE or Nasdaq, but DBS Group (OTC: DBSDY.PK) is one of my "pink sheet blue chips" trading in the over-the-counter market. DBS is well-capitalized and has deep tentacles both in Singapore and regional economies.

Good investing,

Carl Delfeld

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