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The U.S. stock market is making new highs and there is endless talk about China's economic growth and impending economic dominance. From a top-down perspective, investors should look elsewhere to regions that are not in the limelight.

On a risk-adjusted basis, Hong Kong, Singapore, and Taiwan were found to be attractively-priced. In contrast to the People's Republic of China, the currency pricing of these regions within Greater China are cheap after considering the country risk facing outside investors. Investors can capitalize on this by buying the iShares MSCI Hong Kong Small Cap ETF (NYSEARCA:EWHS) and the Taiwan Fund (NYSE:TWN).

Finding the Most Value for the Least Country Risk

Different markets offer different risks and rewards to foreign investors. To evaluate the investment prospects of different foreign markets, different markets were screened for discounts to Purchasing Power Parity, PPP, of their currencies versus the dollar. To assess the risk of investing in nations with the cheapest currencies, Investment Freedom, Property Right, and Freedom from Corruption scores were collected from The Heritage Foundation's 2013 Index of Economic Freedom. Each metric helps weigh risk or value:

The Investment Freedom score assesses restrictions on foreign and domestic investment, legal recourse available to firms and investors, as well as how burdensome regulations are for investors. Higher scores indicate higher freedom, 100 being the highest score.

The Property Rights score assesses how well the government protects private property, how well the government punishes those who unlawfully confiscate private property and corruption in the court system. Higher scores indicate greater property rights, and 100 is the highest score.

The Freedom from Corruption value ranks the uncertainty surrounding transactions and other economic activity conducted in a country. The highest score would be 100 (least corrupt).

Purchasing Power Parity (abbreviated PPP) is a relative price level that would allow customers to buy the same amount of a goods domestically as they could by exchanging domestic currency for foreign currency and then buying that good in a foreign country. Simply put, if PPP holds I would be able to buy the same amount of gas in the United States as I could in Mexico, either by paying X dollars in the U.S. or exchanging X dollars for Y pesos and then buying the gas in Mexico. Since currencies deviate from PPP, investors could convert dollars into a currency with a discount relative valuation and buy more assets in the foreign market than they could with dollars in the domestic market. Over time differences in PPP tend to become smaller, and investors would capitalize this by buying foreign assets when the foreign currency is weak and selling assets when the foreign currency has strengthened.

The relative valuation of a currency is more of a function of its freedom from corruption, as is demonstrated by the lower R-squared value of its linear plot:

(click to enlarge)Scores vs. Currency Valuation

The linear regression was used to adjust currency valuations based on a country's Freedom from Corruption score:

Country

Relative Valuation [PPP]

Investment Freedom

Property Rights

Freedom from Corruption

Adjusted Discount

India

-59.47%

35

50

31

-20.11%

Pakistan

-55.41%

35

30

25

-9.63%

Egypt

-53.21%

50

35

29

-11.71%

Sri Lanka

-50.66%

40

40

33

-13.43%

Taiwan

-47.63%

65

70

61

-40.34%

Ukraine

-44.66%

20

30

23

3.26%

Thailand

-38.98%

40

45

34

-2.82%

Malaysia

-36.85%

45

55

43

-10.32%

Peru

-36.74%

70

40

34

-0.58%

South Africa

-36.51%

45

50

41

-7.84%

Poland

-36.35%

65

60

55

-22.65%

The Philippines

-36.09%

50

30

26

8.62%

Argentina

-34.44%

40

15

30

5.99%

Hungary

-33.51%

75

65

46

-10.18%

Lithuania

-32.86%

80

60

48

-11.67%

Czech Republic

-31.81%

70

70

44

-6.35%

China

-31.53%

25

20

36

2.49%

Mexico

-28.97%

70

50

30

11.46%

Hong Kong

-28.22%

90

90

84

-45.52%

Indonesia

-26.72%

35

30

30

13.71%

South Korea

-26.34%

70

70

54

-11.57%

Turkey

-25.79%

65

50

42

1.81%

Colombia

-19.74%

70

50

34

16.42%

Russia

-16.68%

25

25

24

30.17%

Singapore

-15.52%

75

90

92

-41.38%

Chile

-13.67%

85

90

72

-18.14%

Saudi Arabia

-12.66%

40

40

44

12.80%

Brazil

-1.03%

50

50

38

30.85%

Israel

-0.80%

80

70

58

9.70%

United States

0.00%

70

85

71

-3.40%

United Kingdom

1.67%

90

90

78

-9.22%

Japan

7.50%

60

80

80

-5.53%

Canada

9.93%

75

90

87

-10.58%

United Arab Emirates

20.37%

35

55

68

20.17%

New Zealand

33.02%

80

95

95

3.95%

Sweden

37.34%

90

90

93

10.41%

Denmark

43.51%

85

90

94

15.51%

Australia

51.83%

80

90

88

30.25%

Switzerland

58.60%

80

90

88

37.02%

Norway

72.10%

70

90

90

48.38%

RSQ

0.2406

0.4439

0.6227

Slope

0.0079

0.0091

0.0107

Intercept

-0.6251

-0.6948

-0.7251

These adjusted values attempt to take corruption into account as a currency discount. Some currencies are cheap even after these adjustments were made.

Ticker

Name

Type

Gross Expenses

Net Expenses**

Premium / Discount

P/E*

P/B*

TWN

Taiwan Fund

CEF

1.65%

1.61%

-7.79%

11.49

1.25

EWT

iShares MSCI Taiwan

ETF

NA

0.61%

0.96%

14.83

1.69

FTW

First Trust Taiwan AlphaDEX

ETF

0.80%

0.67%

-0.46%

13.4

1.3

EWH

iShares MSCI Hong Kong

ETF

0.53%

0.53%

-0.56%

15.63

1.19

FHK

First Trust Hong Kong AlphaDEX

ETF

0.80%

0.80%

3.32%

15.08

0.77

EWHS

iShares MSCI Hong Kong Small Cap

ETF

0.59%

0.59%

0.27%

12.1

1.17

GMOTX

GMO Taiwan III

Mutual Fund

NA

1.36%

0.34%

13.61

1.31

ICHKX

Guinness Atkinson China & Hong Kong

Mutual Fund

1.53%

1.51%

NA

10.17

1.21

EWS

iShares MSCI Singapore Index

ETF

0.53%

0.53%

-0.53%

14.44

1.12

iShares MSCI Singapore Small Cap Fund

ETF

NA

0.59%

1.54%

14.95

1.23

*P/E and P/B ratios are forward projections provided by Morningstar.com and Yahoo! Finance.

**For CEFs, total expenses adjusted for interest expense were listed.

Which of these funds are the best deals for acquiring stock investments in these countries?

The Taiwan Fund offers a portfolio with attractive an attractive 11.49 P/E ratio and an acceptable 1.25 P/B ratio. Technology is its highest sector concentration with 24.28% of its holdings. This closed-end fund has allocated 21.27% of its assets to industrials and 19.87% to consumer cyclical equities. This is an acceptable allocation and does not overweight financials (5.29%) or real estate equities (11.12%). The discount to net asset value offered by this fund somewhat balances the high fees it charges.

Another attractive investment vehicle is the iShares MSCI Hong Kong Small Cap ETF, which offers a portfolio with a reasonable P/E ratio of 12.1 and a reasonable P/B ratio of 1.17. The fund's highest sector weight is 37.3% for consumer cyclical stocks and it is not excessively concentrated on financials (8.04%) or real estate (11.23%). Its fees are also low, making it an attractive investment vehicle for the region.

Not all funds on this list are attractive or appropriate for exploiting this top-down analysis. The Guinness Atkinson China & Hong Kong mutual fund is much less attractive as an investment. Its fees are high, but unlike the Taiwan Fund, this mutual fund does not trade at a discount to counterbalance these fees. Most of its largest holdings are in mainland China, which means that the top-down analysis that favors Hong Kong only slightly applies to this fund.

First Trust Hong Kong AlphaDEX may appear attractive based on its low P/B ratio, but this fund is overweight the real estate sector: 52% of its portfolio is real estate holdings while the benchmark weights this sector as 7.74%. This is risky in a region where a bubble in real estate has become a contentiously debated issue.

Please read the article disclaimer.

Source: Greater China, Greater Value