September 20, 2007
Hard Decision on China A-Shares Investment

Travis Johnson Submits: Well, one day -- actually a little bit less than 24 hours -- after I bought shares of the Morgan Stanley China A Shares closed end fund again, and the market tries to force some decisionmaking on me.

Why? Because the domestic Chinese stock market remains largely cut off from and uninfluenced by the rest of the world's markets.

Now, one argument is that this is certainly a reason to buy in if you can -- that's a kind of diversification that's hard to come across these days, thanks to the Chinese restrictions that limit foreign ownership of A shares, and limit ownership of foreign shares by Chinese citizens.

But another way to look at it is that the 20%+ discount to NAV that the fund was trading at yesterday morning has fallen significantly, down to close to 15% again as the US-traded CAF shares have enjoyed the market's rise and the return of optimism thanks to our latest rate cuts.

You see, the Shanghai and Shenzen exchanges were just about the only bourses that didn't see a pretty substantial rise yesterday/today (depending on where you are in the world). So in the last 24 hours the price of the CAF shares has risen about 8-10%, but the net asset value of the fund has actually declined slightly, since the Chinese markets were down a hair in their last trading session.

I just bought these shares, and I'm not quite ready to sell them yet -- I think that the domestic Chinese shares are likely to climb further, and I'm willing to give it at least a couple days. I will keep my stops tight to protect this surprisingly quick 10% return, but I think there's more to come.

If this same thing happens tomorrow, however, and the CAF shares narrow the discount further, I may be tempted to sell and book my profit. I think a 10% discount is probably reasonable for these shares, since that's close to where most closed end funds end up trading and this one carries a fairly substantial 2% management fee, but I'd argue that anything above that is a significant opportunity now, especially if you really want exposure to the Chinese economy that's not particularly swayed by US markets.

No guarantees on what I'll end up doing, however, since these shares also have traded at a substantial premium (albeit briefly, near their IPO last fall), and arguably ought to trade at a premium as the single best way for US investors to get direct exposure to the tightly controlled Shanghai and Shenzen domestic share stock markets.

Unless, of course, you believe that the A Share market is on the verge of popping like the good 'ol Nasdaq bubble ... I don't, though I think risk of some decline is high in general, but I can certainly see the validity of that point of view.

Just remember: Chinese income is climbing and their savings rate is at about 40%, and their bank deposits are losing money in real terms (due to inflation). Chinese citizens can buy property now, to some extent, though urban property can be incredibly expensive in some areas, but other than that they're pretty much stuck putting that savings into their stock market if they want decent returns (and some economists are now arguing that the reason for the high savings rate is that Chinese citizens want to invest in their economy).

(Source: SeekingAlpha)