Tuesday 24 July 2012

Spotlight on China

A closer look at the FTSE China 25 Index

China at the moment is one of the best funds to invest in based on expected returns using our valuation method (see previous postings on adjustment rate and core funds valuations for more info). Estimated returns look close to 8% pa at present due to high growth rates for China and low PE ratios on the market at present.

The chart below shows the 5 year price action for FXC.L (ishares FTSE China 25 fund):



The credit crisis of 2008 resulted in some increased volatility. Following that the fund increased in value by 130% from its low in 2008 to its peak in 2010. Since then the price has been up and down without any clear trend. At present the fund is 38% below its peak in late 2007.

Due to the large size of the market that the fund covers (estimated market cap of the underlying stock in the fund total almost US$2trillion) we are less concerned with using technical analysis. (We reserve technical analysis for smaller funds, stocks and commodities. Stocks and small funds are riskier and technical analysis can give warning signs of information that is not always visible from fundamental analysis alone. For commodities technical analysys is used as trends tend to continue for longer periods to waiting for the right time is critical)


 

Sector Allocation

The pie chart below shows the sector allocation of the FTSE China 25 index (remember this index only contains 25 stocks):



As you can see the fund is pretty heavy on financial stocks making over 50% of the index.

Let's take a closer look at the main financial companies that make up the index. The table below summarises the data:


Stock
Market Cap
PE
Div
High
Current
Change
China Construction Bank
US$160b
5.70
5.3%
1.09
0.62
-43%
Ind & Comm Bank of China
US$203b
5.65
5.4%
0.91
0.53
-42%
Bank of China
US$115b
5.04
6.2%
0.66
0.36
-45%
China Life
US$86b
30.27
1.4%
81
40
-51%
Ping An Insurance
US$60b
19.80
0.3%
24.30
15.54
-36%

The banks are all on modest PE ratios of 5-6 and pay generous dividends. The banks are all more than 40% below their high prices so some downside risk has already been removed. The insurance companies look a bit more pricey but those too have seen significant falls.

The high concentration of the index on financial stocks makes me a bit wary. The banks look reasonably priced and are discounted from their highs so their is some upside potential. If you can stomach having over 50% of your assets in financial stocks then the returns do look attractive. I think the lack of diversity in the fund and the sheer complexity of valuing financial stocks means this fund probably shouldn't make up a significant part of your overall portfolio, certainly less than 25%.






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