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Over the last two days we have reviewed the Chinese yuan exchange rate, its anticipated rise and how that presents an opportunity for owning Chinese stocks. Funds seem to be the best route, and here are criteria for selecting a promising one.

Get local management

The fund manager should be in the region and fully understand the culture – preferably as a national or long-term resident. A fund manager sitting in New York or London rises late in the Asian day, reads the news from afar, checks the computer screens, talks to analysts in the region, meets with company management that has come to town, takes an occasional trip to visit the region – then makes decisions about securities whose issuers are truly foreign to his/her life. This process doesn’t come close to the understanding that a manager on the ground has. Foreigners are indeed inscrutable – to someone who is not immersed in the everyday life and culture.

Avoid index funds, including ETFs, and quantitative (i.e., computer-based) fund management

Investing success in developing (AKA emerging) countries requires a savvy fund manager to decide where and when to invest. Developing countries also have developing markets, economies, regulations, laws and accounting/reporting rules. Leaving it to a data-dependent, computerized decision process can produce mediocre returns (or worse), and carry higher risk.

Good example: I was meeting with one of my Asian managers and asked why he owned a higher-priced company rather than a similar one that was more attractively priced. (I had seen a quantitative manager using this as an example of adding value.) He said the cheaper price was well deserved, and probably too high, because the president of the firm had a record of shady deals, so could not be trusted.

This active management carries higher fees and expenses. They are well worth it.

Avoid leverage

Developing market investing has plenty of potential return and risk, so there is no need to ramp it up. Adding debt to a China stock portfolio is like adding caffeine to a red squirrel’s diet (a la Hammy in Over the Hedge). Both can lead to road kill.

Put closed-end funds high on your list

Closed-end China funds are well-managed and are “on sale.” The primary funds are listed below (click to enlarge image).

(*) China refers to the “People’s Republic of China” (PRC) or “Mainland China.”

Don’t fully understand closed-end funds? I will be covering these in general tomorrow. They currently offer good value and should be considered for some investing strategies.

So, now seems to be an opportunistic time to invest in Chinese stocks. Doing so with a well-managed, un-leveraged fund is a good strategy. Closed-end funds currently offer a discount and additional advantages (to be discussed tomorrow).

Disclosure: No positions

Source: Investment Implications for the Chinese Yuan's Anticipated Rise: Part III