When Looking Into Investments Like Real Estate Or Art, A Global Perspective And Awareness Of Chinese Culture Should Be Taken Into Account
The Motley Fool recently did a piece on “The Wrong Way to Invest in China,” detailing how most investors who want to get into the not-as-hot-as-before-but-still hot Chinese market often think that the best and safest way to do so is to dive in with exchange-traded funds like the iShares FTSE/Xinhua China 25 Index (FXI). Despite the popularity and relative success of this fund, by going with these bundled funds investors are missing out on the exact thing that makes the Chinese market so attractive for investment — the inventiveness and dynamism of the companies that power its growth:
By investing in FXI, you’re not sufficiently tapping into the entrepreneurial spirit of the Chinese people. See, FXI tracks a FTSE/Xinhua index mainly comprising state-owned enterprises (SOEs). In fact, of the top 10 holdings of the exchange-traded fund, 10 are SOEs (or are subsidiaries of SOEs, which for my purposes are one and the same).
Basically, jumping aboard FXI looks great — with its growth, relative to non-Chinese funds, but in actuality it is the involvement of these SOEs that holds it back, since the Chinese government has spun these enterprises off at an increasingly rapid pace since the 1970s. At the rate its going, getting too tied up with SOEs now could cause big problems later. And the monolithic SOEs that the government does hold onto for the long term may not be as concerned with making profits as their smaller competitors, since they will continue to lean on the support given them by the CCP.
The Chinese government has certainly reduced its ownership of some SOEs, but given the size of those companies and the size of the government’s remaining ownership, it could be a long time before those SOEs are fully privatized. Just imagine if the PRC decided to suddenly dump its huge stake in China Life Insurance into the public markets. It would be an utter disaster for those shares.
The bottom line is that, despite the loosening of the PRC’s grip, SOEs still do not put shareholder interests first. Their motivation is still at least partly political, so you’re better off looking for Chinese companies that have your interests at heart.
Looking into buying stock in China’s high-flying, profit-minded startups and entrepreneurial outfits like Sohu and New Oriental Education. Not a bad idea, given the huge growth that these companies have seen (particularly Sohu, whose gaming spinoff Changyou’s recent IPO turned heads). But, for investors mindful of the risks of the Chinese market and the uncertainties and bureaucracy often involved with mainland investment, it might be better to look at more creative options, as many foreign investors have in the last five or 10 years. Generally, these investments have been in hard assets like real estate, antiques, and artwork. As recent figures have shown, the real estate market in China has been hit pretty hard by the current downturn. Not as bad as in the US, but the country is far from unscathed. As the Boston Globe reports,
Home prices fell a record 1.2 percent in February across China. I guess that is pretty bad over there, though, at this point, that sounds like a pretty good month here in Massachusetts.
Housing prices in China’s top 20 cities fell 5 percent in March, with Beijing and Shanghai having the biggest gluts of unsold homes.
Developers have been responding with all sorts of incentives, while the government has dropped interest rates and started to pump stimulus money into the economy.
Sounds familiar, right?
However, all of this should be pretty obvious to investors — prices are down globally for all assets, even the aforementioned hard assets. In China, this is no exception. And in markets for real estate and artwork, two markets that have skyrocketed in the last five or so years, observers are quick to declare that both markets in China are done. However, I feel differently. I think that recent events have shown that — while real estate is still up in the air because there is a glut of supply and lower demand from more frugal and predominantly domestic buyers — the Chinese art market is built on the fact that there is a global demand (for contemporary art and antiques alike) but scarcity in supply and a global base of buyers completely independent from China itself. So any perceived weakness in the contemporary Chinese art market from Sotheby’s recent sale — which saw most pieces sold, but prices down from last year — is a bit premature. Contemporary art has seen a more significant price adjustment than antiques recently simply because contemporary artists are still alive and working — yet still scarce, since top artists have not released many pieces in the last several years — meaning that supply (while finite) will continue, albeit slowly. That is not the only thing separating these two markets, though, as younger or fresh collectors tend to make up the growing contemporary art collector base in the mainland, unlike antique collectors who tend to be a bit older and less willing to try new asset classes. I would expect that scarcity will become an even more talked-about issue in Chinese contemporary art in the next few years, as this growing domestic collector base quickly absorbs new output by top artists. The point being: don’t just look at antiques, which have a defined finite supply, to strictly follow the rules of supply and demand. When supply slows down and demand speeds up, the same rules apply.
To get back to the original point, investors who want to get into China have to weigh the risk they are willing to take to do so — just like in any investment. Investing in SOEs is relatively safe, because the big SOEs are certain to continue to do well, but they are far from certain in this era of the Chinese government looking to increasingly wash its hands of business involvement in some non-critical areas. Investing in startups and entrepreneurial hotshots can bring huge returns, but it’s risky. Investing in real estate is not a bad idea, but it also leaves investors vulnerable to “bubble” devaluations like we have seen recently. Also, investing in real estate involves dealing with a good deal of red tape (as a foreigner). So, despite the rash of hasty reporters looking to declare that the contemporary Chinese art market was just a sham all along and that the fact that 27% of artists did not sell at auction a couple of weeks ago indicates that it’s all over, I think Chinese art still represents a good way to grab Chinese assets — especially now, since they are cheaper but not cheap. Also, buying contemporary art helps avoid the red tape often involved with buying Chinese antiques.
As the Chinese market matures, investment in China (as a foreigner) will either become more transparent and easier or more opaque and confusing — it’s anyone’s guess at this moment. So, as The Motley Fool said, there’s a right way to put your money in China and a wrong way. How you define both is entirely up to your goals in that market. I think, as the recession eventually begins to taper off, we’ll see real estate and art prices roughly pace the Chinese stock market, although I still think that the oversupply in the Chinese market will keep real estate prices relatively low. Like I said, although China has a vast population, and a huge proportion of people are still waiting to buy their first home, Chinese consumers have proven over the last several thousand years that they don’t like throwing all of their savings into something they’re not sure about. With the global demand for artwork, though, I think prices will see an earlier uptick. It’s all about asset diversification, so foreign investors in China need ot look at the big picture of the country. It’s an ever-changing place, with a blazing entrepreneurial spirit and stiff competition — you really have to be on the ball about what to invest in and when to do it — and, maybe, for those investors who want to get in on some Chinese assets, doing this could be as simple as hanging a painting on your wall.