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Jacob Wolinsky
Jacob Wolinsky
Articles  | Author's Website |

Why Investors Do Not Need China in Their Portfolios

In a previous article on ValueWalk.com I took a look at a recent op-ed by Burton Malkiel, in which he listed some reasons for investing in China. I played devil’s advocate and defended Malkiel’s suggestions, in this article I am going to refute them.

The article entitled, “Why Investors Need China in Their Portfolios,” appeared in the WSJ several weeks ago. Malkiel author of the best-seller A Random Walk Down Wall Street stated that investors are under-allocated in China, and should gain more exposure to the world’s second largest economy. Malkiel wrote that China is growing rapidly yet valuations are still reasonable.

Malkiel states that many Chinese ETFs are not too pricy with their PEs in the teens. He does not state if this is 13 or 19. Malkiel also does not state where he is getting his numbers. Are they trailing twelve months? Forward earnings? etc. It is easy to get earnings on almost any company in the US from dozens of websites, and of course from SEC filings.

The concept of diversification, consists of spreading your wealth (and therefore your risk as well) among various asset classes. Therefore, after careful asset allocation, you will still have your losses minimized in a worst case scenario where one asset class performs poorly the other asset class will perform well.

But, diversifying simply for the sense of diversifying does not necessarily mean you are setting yourself up for success. Asset classes have become increasingly correlated, with 2010 being a good example, where nearly every asset class went up. Additionally, it does not make sense to diversify into an asset class that is overvalued like long term treasures. Warrant Buffet coined the term ‘diworsification, as many investors will buy good stocks along with junky ones for the sake of being “diversified”

Burton Malkiel is the champion of asset allocation, not individual stock picks. Malkiel believes the market is efficient and stock picking is a waste of time (although, I must note that he believes the Chinese market is less efficient than US markets) Most people reading the article likely do not realize that. While it might be a good thing to have exposure to growing economies, it is even easier to get crushed on individual Chinese equities than American equities.

In the United States, we follow specific accounting rules such as G.A.A.P. (generally accepted accounting principles) which we can understand because we have been trained to abide by them. Other specific laws of business, whether they are of corporate and industry policy and standards or they are of country specific laws, we get them. However, certain items that affect our business activities from marketing and advertising, to accounting and interest are all handled differently across different national borders. Just like you can’t expect to play blackjack using solitaire rules, you also can’t expect to invest in China and be successful by only using the techniques learned from trading specifically in US markets.

Here is some data about China from PricewaterhouseCoopers:

IFRS required or permitted for listed companies?

No, however, CAS (Chinese Accounting Standards) have somewhat converged with IFRS. However, it is not a direct translation of IFRS. Several differences remain between CAS and IFRS; however, as time goes by, the Ministry of Finance has plans to eliminate those differences.

Now I have trouble memorizing all the GAAP rules let alone IFRS and certainly not CAS. I would not even trust that the numbers are accurate. As incompetent as the SEC is one can only imagine how bad the regulatory authorities are in China. Even if China reported under GAAP or IFRS I would not know if the auditors or regulatory authorities could be trusted to ensure accurate financial statements.

I think the last point is the most important. In yesterday’s WSJ there was an article titled Why Stocks Don't Always Boom With the Economy, which demonstrated no correlation between stock returns and GDP growth. This will shock all the BRIC bulls, but the study covers a long period of time; 1988-2010. According to the article, while China’s real GDP grew 9.5% per annum from 1993-2010, Chinese stocks only had real returns of 2.2%. This is referring to the Shanghai Exchange; surprisingly the Hong Kong exchange had even worse results.

I am not stating that China should be avoided when it comes to investing. The truth is, for any given investor, investing in China can still be a great idea. But it doesn’t mean that you should just dive headfirst into the market without actually doing your due diligence first. Warren Buffett bought a large stake in BYD, which trades on the Hong Kong exchange; however, most of us are not Warren Buffett. It would take a lot of time and feet on the ground to really find good Chinese stocks.

If you want to invest blindly in individual equities, ETFs, or even index funds in China do so by all means, but remember Malkiel makes it seem much easier then it truly is.

Disclosure: No holdings

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website

Rating: 3.8/5 (10 votes)


Energywonk - 8 years ago    Report SPAM
not a bad effort jacob. i find very little value in china and i mimicked buffetts purchase of BYD around 6 weeks after he purchased (my average price was around 11.48-11.54) i should have sold at 80!! they are now around 30!. some great durable companies will emerge from china and i feel byd is one of these, but i think a better and safer option for most is to buy equities etc in companies and countries leveraged to china. for instance canada and australia where amazing companies like BHP, Woodside petroleum, etc exist. that said i feel australia has enourmous property bubble and from what i read canada too. its not an easy market right now but with a long enough view, commodities should perform well as the US destroys its currency.
Guruek - 8 years ago    Report SPAM
Jacob, What are the other countries in which companies follow GAAP?
Yswolinsky - 8 years ago    Report SPAM
Off the top of my head, USA and I think Canada follow up, although I believe Canada is switching to IFRS. I will see if any more countries follow GAAP, none come to mind currently.

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