And ... back to the A Shares

Like a sloppy drunk returning to the roulette table, I've repurchased a position in the Morgan Stanley China A Share Closed End Fund (CAF).

Those who've been keeping up here (not so many of you, since I keep neglecting to post in a timely fashion), will remember that I bought these in the Spring because the discount was ridiculous, then sold when the discount shrunk to about 15% and the price was up well over 50%.

Well, I'm doing it again. I still see no fundamental reason for the decline in the A share market in the near future -- inflation is getting crazy in China, which should be good for stocks at least in comparison to bank deposits (and there isn't much else that the Chinese can do with their prodigious savings glut, even though they're beginning to loosen the restrictions a little bit and let some investors sample overseas fare).

And the discount is now back over 20% in this closed end fund.

So, I picked up some more shares today at an average of about $61.50.

This is, again, one of the few positions that I'm very cautious about -- I do have a trailing stop on these shares, which I almost never do with any other holdings, and I'm likely to sell if they continue to climb significantly and the NAV gets a little closer to the share price again.

But really, though I'm somewhat trepid about this position, I do think the A shares have quite a bit more potential in the short term of 6-12 months. Beyond being the most direct way of investing in the domestic Chinese economy, in my opinion, this is a play on supply and demand in two ways:

1) Chinese domestic investors have very few investments available to them, and they're mostly stocks on the domestic (Shenzen and Shanghai) A share market. So the A shares trade at a significant premium to the same company on the Hong Kong exchange, for example, in cases where companies have dual listings.

And 2) International investors have very little ability to invest directly in China. So this fund should trade at a premium to what foreign investors believe is the fair market value of the China A shares overall index.

The risk is that number 1 is moderated somewhat as the Chinese get the freedom to invest overseas -- but my bet is that this process will be extremely gradual, as most Chinese policy changes are, and that number 2 exposes the fact that most foreign investors believe the China A shares market is dramatically overvalued (due to number 1, mostly), so they may be paying a premium to what they believe the fair value is, but they believe, en masse, that the fair value is lower than the current net asset value.

So ... another gamble in a risky, isolated market. But frankly, in some ways I find the Chinese A share "bubble" companies to be somewhat more appealing than their US counterparts these days. If China can continue growing at 10% a year, as most believe they will come close to doing, especially as domestic consumption climbs in the Middle Kingdom, the valuations just aren't necessarily as crazy as they might look to jaundiced Western eyes that lived through the Nasdaq bubble.

We'll see, as usual ... I am leaving room to accept the fact that I'm wrong, and that an abrupt crash in the domestic markets in China is possible.

Full disclosure: I own CAF, and the China Fund CHN, as well as call options on the Hong Kong Index (EWH) and several individual positions in Chinese and asian stocks not directly mentioned here.

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A little Crazy ... a Little China

In what might be a dumb move, I've picked up shares in a couple of China closed-end funds in the last few days.

I've tried to hedge my bets a little bit, however: I have acquired shares of both the China Fund (CFN) and the Morgan Stanly China A Shares fund (CAF). These are extremely different investments, which I'll explain briefly. Basically, the China Fund is a mutual fund that buys stable, perhaps less-well-known companies that generally trade on non-mainland exchanges. I'd consider this to be the more stable fund, and a good long term investment. The China A Shares fund represents an investment in the actual bubble -- the Shanghain and Shenzen traded A shares market that is dominated by Chinese retail investors. Both trade at stiff discounts to their net asset value -- something on the order of 20% discounts in both cases, though that fluctuates a lot on any given day.

The China Fund is a more typical China mutual fund, with a long history, that happens to trade as a CEF. They have a couple of advisors, and they focus on buying non-state-controlled entities (this approach is common to many China stock advisors, including the newsletter editor Robert Hsu, who think the state owned enterprises are too bureaucratic and corrupt). I like this one because I appreciate the focus on smaller and unknown stocks that it would be difficult for me to buy personally -- they don't invest much on the A share market in Shanghai, but buy primarily Taiwanese and Hong Kong and other regionally traded shares that represent Chinese companies, or companies that primarily do business with China.

As of the end of April, their top holdings were:

Shanghai International Airport
Chaoda Modern Agriculture
China Merchants Bank
Daqin Railway
Shanghai Zhenhua Port Machinery
Golden Meditech
Financial Street
Xinjiang Tebian Electric
China Yangtze Power
Baoding Tianwei Baobian Electric
Powertech Technology
Cathay Financial
Merry Electronics
Formosa Petrochemical
China Oilfield Services

So I consider CHN to be a long term hold, which could obviously change. The expense ratio is a relatively reasonable 1.26%. CHN is now near a 20% discount to net asset value, which is nearly as high as the discount has ever been -- in contrast, the premium has occasionally gone as high as 60%, though I don't expect we'll see those numbers again. I don't think this fund deserves to trade at the same high discount as CAF, below, because of their relative lack of exposure to Chinese retail investors.

The China A Shares fund from Morgan Stanley (CAF) is more of a short-term bet for me. I think that it's entirely possible that the Shanghai markets will continue to climb for the rest of the next 12 months, on balance, even following the remarkable returns they've already had over the past year. There are definitely a lot more negatives with this fund, including massively higher expected volatility, but I think it's worth a gamble. With the shares trading at something like a 20% discount after being at almost as much of a premium as recently as December, and as the Chinese A share markets have continued to set new records despite all the talk of bubbles and state imposed control. This is essentially a small bet that at some point in the next few months -- before the Olympics next year, certainly -- US enthusiasm for the China A shares will return and that the markets will not have a crash. I could easily be wrong.

The top holdings of CAF, as of the end of March, were:
Huaxia Bank Co. Ltd
China Merchants Bank Co. Ltd
Shanghai Pudong Development BA
Daqin Railway Co. Ltd
Wuhan Iron & Steel Co. Ltd
Air China Ltd
Shenzhen Chiwan Wharf Holdings
Zhengzhou Yutong Bus Co.
China Coal Energy Co.
Maanshan Iron & Steel

As you can see, fairly limited overlap -- Dagin Railway and China Merchants Bank are in both funds, though I expect the CMB holdings in CHN are Hong Kong shares, not Shanghai (many companies list in both exchanges, at often different valuations). I've actually looked at China Merchants Bank as an independent investment idea before (in Hong Kong), because of their strong credit card business developing on the mainland, so I'm happy to have those shares doubled up in these positions.

The expense ratio is a relatively high 2%, thanks to the uniqueness of their portfolio in US markets, which is part of the reason I won't plan to hold this one for a very long time -- perhaps as much as a year or so, depending, of course, on how the market changes. I will likely keep a stop loss order on this one, which I almost never do for any investment.

So ... a couple Chinese investments. One long term because I like the investment strategy, one short term because I think the panic about A shares might be overdone ... and that short term one is on a much shorter leash, too. The CHN shares I purchased at $35.08, the CAF shares at $36.11.

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