Why I'm Buying Morgan Stanley China A-Share Fund

As mentioned last week, the Chinese large caps (as laid out in ETF FXI) were lagging the market and signaling a tired story. I've long thought China would be among the first tranche of countries to bring on the recovery. I still believe that, but believe traders are way too early on this thesis based on the Chinese government essentially pulling an Alan Greenspan [Feb 16: Is China Pulling an Alan Greenspan?] or in this case a Ben Bernanke. Money is flowing in all directions, and economic data will skew higher, as will stocks. As always, the market is not about what is correct or what I believe in, but what the herd believes in.

There are two main ways to play the "Chinese non speculative" arena - i.e. mid and large caps stocks

1. FXI as mentioned above is an ETF for US listed Chinese stocks of quite large size.
2. CAF is the closest thing we have to investing in the Shanghai market itself

I am using the latter; details can be found here, but again these are not companies listed on US exchanges - essentially this is a way to play the homeland index.

Technically the ETF has had a huge run and in a bull market is exactly the type of chart we love. After topping at mid $36 range, the ETF has pulled back to mid $32s filling a gap from April 8th/9th - so I am going to start a 2% position here just above the 20 day moving average. I'd like to snag some down around the 50 day moving average below $30 if we continue to weaken in the market.

As an aside, it appears Van Eck is coming out with an ETF as a pure play on Chinese A shares

• Van Eck Global Advisors has filed to launch the Market Vectors China A-Shares ETF on the New York Stock Exchange. The proposed ETF would start by dealing in swaps and derivatives to mimic its underlying index.
• As noted in the filing, so-called A-shares in China are largely only made available to local investors. But there are some cracks opening in China's wall to outside investors: Namely, the Qualified Foreign Institutional Investor program, a special license granting foreign investment groups access to local markets. As a result, Van Eck says it'll apply for QFII certification.
• "There is no assurance that the adviser will be able to obtain a QFII license and, if so, when such license would be granted," said Van Eck in its filing, which is dated March 30. In the meantime, Van Eck will seek other ways to gain exposure to what it describes as a sometimes volatile and illiquid marketplace. "Therefore, unless and until the fund is able to invest directly in A-shares, the fund intends to invest in China A-share Access Products [CAAPs], swaps and other types of derivative instruments that have economic characteristics that are substantially identical to the economic characteristics of A-shares in order to gain access to the A-share market," the filing states.

As stated late last week, I was positioning for a moderate correction [Bookkeeping: Positioning for Correction] - mostly by selling long positions (raising cash) rather than outright shorting since my head has been handed to me the better part of 3 weeks shorting anything. I'd like to deploy those funds slowly on the long side as the market retreats, with initial support in the S&P at 840, 830, and 820. Below S&P 820 the case for the bulls becomes more troublesome. As long as we hold S&P 780, I am willing to continue my case for a wide trading range and would like to have both long and short positions. It's been very difficult to execute this strategy because most days everything is either to be sold or bought - no happy mediums of calmness.

I wrote the past week or two I am now of belief that industries not under the government's arms and facing the "real economy" rather than Nanny State economy could be the disappointers - Eaton (ETN), an industrial we tagged in the earnings preview for Mon-Tue did just that. Further, Bank of America (BAC) despite "shockingly good" results, was sold off - as I said in that same piece: anyone still surprised by bank results has been living in a cave for 2 weeks and at some point all the "good news" is baked in.

Disclosure: Long Morgan Stanley China A Share in fund; no personal position

Comments

[Dustinian:]

PGJ is my favorite China ETF in the long run because it has large exposure to resource prices, and plays into the ever growing Chinese niche of online gaming.

Apr 21 10:13 AM

[Ron Rowland:]

I have a hard time understanding why anyone would want to pay an 18% premium to buy a fund. Is the CAF club really that exclusive?

Apr 21 10:20 AM

[Larry House:]

I know mutual funds are detested by many, but I like MCHFX. I have been in it for several weeks and view it as a good multi-year holding.

Apr 21 10:58 AM

[Alan Young:]

CAF is not an index ETF, but a CEF. It is currently trading at an 18% premium. So you're not just relying on Chinese investors to keep their home share prices rising, but also on US investors to keep paying the premium. If Shanghai falls, CAF could fall twice as much; but there is no corresponding upside leverage.

Apr 21 01:01 PM

[Jake2:]

"I've long thought China would be among the first tranche of countries to bring on the recovery."
Poor choice of words. "Tranche" has a negative connotation, or, as it were, a "toxic" connotation. Countries don't come on in tranches anyway. They "emerge" one at a time, and then in physical areas or sectors or the world, along with trading partners, for example. A bas les tranches!

Apr 21 01:03 PM

[rlirph:]

As of today the A shares in general trades at a 37% premium to its underlying H shares. This is reflected in looking at the Hang Seng China AH Premium Index. The underlying stock is identical except one is listed in China while the other one is listed in Hong Kong.

Because the China's market is closed to outsiders (including Hong Kong residents) stock prices in that market can be different than the same stock listed in Hong Kong. With the eventual opening up of China's financial market who will be willing to pay this 37% premium?

An US expat living in Guanghzou...

Apr 21 08:47 PM

[Topgun:]

Yeah, buy more and pay more premium, some greater fool will get in anyway, you da man.

Apr 21 09:22 PM

[huangjin:]

China loaned as much money in Q1 as in all of 2008, when the economy was growing at 11%+ per quarter, annualized. The state forced the banks to lend and the companies accepted the cash, and parked as much as one-third of it in the stock market.

Apr 22 09:04 AM

[searcher:]

You are paying a premium to access a local market that is at a premium to reality. Don't see the point unless I had high confidence in the management's trading ability as it swaps horses.

Apr 22 12:47 PM

[Topgun:]

are you buying a lot? are you gonna hold it for a long time? do you realize that on top of the 37% or so premium that A shares are above their H shares, CAF is also trading at 30% premium so you maybe paying 60% plus premium. But don't worry, just follow your trendy TA and in no time, it would reach 100$, and you will be a millionair, just another TA millionair that it.

Apr 23 07:56 AM