September 19, 2007
Back to China A Shares: Am I Suicidal?

by Travis Johnson

Like a sloppy drunk returning to the roulette table, I've repurchased a position in the Morgan Stanley China A Share Closed End Fund (CAF).

Those who've been keeping up here (not so many of you, since I keep neglecting to post in a timely fashion), will remember that I bought these in the Spring because the discount was ridiculous, then sold when the discount shrunk to about 15% and the price was up well over 50%.

Well, I'm doing it again. I still see no fundamental reason for the decline in the A share market in the near future -- inflation is getting crazy in China, which should be good for stocks at least in comparison to bank deposits (and there isn't much else that the Chinese can do with their prodigious savings glut, even though they're beginning to loosen the restrictions a little bit and let some investors sample overseas fare).

And the discount is now back over 20% in this closed end fund.

So, I picked up some more shares yesterday at an average of about $61.50.

This is, again, one of the few positions that I'm very cautious about -- I do have a trailing stop on these shares, which I almost never do with any other holdings, and I'm likely to sell if they continue to climb significantly and the NAV gets a little closer to the share price again.

But really, though I'm somewhat trepid about this position, I do think the A shares have quite a bit more potential in the short term of 6-12 months. Beyond being the most direct way of investing in the domestic Chinese economy, in my opinion, this is a play on supply and demand in two ways:

1) Chinese domestic investors have very few investments available to them, and they're mostly stocks on the domestic (Shenzen and Shanghai) A share market. So the A shares trade at a significant premium to the same company on the Hong Kong exchange, for example, in cases where companies have dual listings.

2) International investors have very little ability to invest directly in China. So this fund should trade at a premium to what foreign investors believe is the fair market value of the China A shares overall index.

The risk is that number 1 is moderated somewhat as the Chinese get the freedom to invest overseas -- but my bet is that this process will be extremely gradual, as most Chinese policy changes are, and that number 2 exposes the fact that most foreign investors believe the China A shares market is dramatically overvalued (due to number 1, mostly), so they may be paying a premium to what they believe the fair value is, but they believe, en masse, that the fair value is lower than the current net asset value.

So ... another gamble in a risky, isolated market. But frankly, in some ways I find the Chinese A share "bubble" companies to be somewhat more appealing than their US counterparts these days. If China can continue growing at 10% a year, as most believe they will come close to doing, especially as domestic consumption climbs in the Middle Kingdom, the valuations just aren't necessarily as crazy as they might look to jaundiced Western eyes that lived through the Nasdaq bubble.

We'll see, as usual ... I am leaving room to accept the fact that I'm wrong, and that an abrupt crash in the domestic markets in China is possible.

Full disclosure: I own CAF, and the China Fund CHN, as well as call options on the Hong Kong Index (EWH) and several individual positions in Chinese and asian stocks not directly mentioned here.



(Source: SeekingAlpha)