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Even with some uncertainties about the market, investors need the right level of exposure to China.NanoStockk/iStockPhoto / Getty Images

A slowing global economy and a trade war with the United States have taken the shine off China as an investment theme. But its recent fall from grace presents an opportunity.

“The uncertainty caused by the escalation of the trade war has seen China fall out of favour,” says Catherine Yeung, investment director with Fidelity International Ltd. in Hong Kong.

Still, she says the nation remains an attractive long-term investment, with its markets arguably on sale.

“Valuations have come off their peaks, and many stocks are now trading at attractive levels,” Ms. Yeung says.

The MSCI China Index, which consists of large- and mid-cap firms, was down by almost 19 per cent in 2018 – although it’s up by more than 7 per cent year to date in 2019.

What’s more, the price/equity ratio for China’s Shanghai Stock Exchange – the country’s largest equity market – has been bouncing between 13 and 14 of late. That’s down from its recent peak of 25 in 2015 and a far cry from the all-time high of more than 70 prior to the global financial crisis.

Certainly, investors have more reason than China’s battle with the U.S. to be leery about owning Chinese stocks and bonds. Its economy has been slowing. The country’s gross domestic product (GDP) growth rate has fallen by about half since 2010.

Nevertheless, China’s annual economic growth rate of 6 per cent remains roughly three times that of many developed economies, Ms. Yeung says.

As such, not everyone is avoiding this economic giant. Many financial advisors already have an allocation to China through an emerging-markets fund, says Christine Tan, portfolio manager at Sun Life Global Investments Inc. (SLGI) in Toronto, who specializes in emerging markets.

“Using a broadly diversified emerging-markets [fund] is probably a good first step,” she says.

Ms. Tan notes that China makes up about one-third of a typical emerging-markets offering. Among managed all-in-one portfolio solutions, emerging markets generally make up about 8 per cent of the portfolio.

She says this level of exposure will suffice for some. But advisors working with clients who have a long-term horizon should consider investing directly in China because of its growing economic importance.

Although China remains the second-largest economy in the world, “it should surpass the U.S. in the next couple of years,” Ms. Tan says.

One catch is that China’s bond and equity markets are still developing and don’t reflect the country’s economic might.

“China remains underrepresented in global equity indexes,” Ms. Yeung says.

Although China’s share of global GDP currently is about 19 per cent, International Monetary Fund data from July show that China’s stock market representation is less than 4 per cent in the MSCI All Country World Index.

Ms. Yeung says the inclusion of A shares in MSCI’s indexes is a step in the right direction to increasing China’s weighting. These are shares in companies operating in China, listed on Shanghai and the Shenzhen stock exchanges.

The move earlier this year by MSCI illustrates growing access to Chinese markets, overall, by foreign money. Individual investors remained challenged to buy A shares. But institutional investors, like managers of exchange-traded funds (ETFs) and mutual-fund managers, can buy these unadulterated Chinese stocks.

Previously, most foreign investors allocated capital to China through indirect means, such as buying H shares. These are stocks in firms operating in China listed on the Hong Kong Stock Exchange. Additionally, foreign money could invest in B shares (Chinese firms listed in China but trading in foreign currencies) and American depositary receipts (ADRs) listed in the U.S.

“You can go cross-eyed with these different types of shares [fund] firms have had to own to get around restrictions on A shares,” says Lara Crigger, senior staff writer at in New Orleans. “But A shares are like the Holy Grail.”

That’s because they offer direct investment into China. As opposed to a universe of, at best, a few hundred, large-cap Chinese companies through other share types, A shares potentially allow direct investment in thousands of companies of all sizes.

Ms. Crigger says advisors “must still look under the hood of ETFs to figure out what kind of shares they own” because many established ETFs remain a blend of A, H and other classes. Among them are the two largest by assets under management: iShares China Large-Cap ETF (FXI-A) and iShares MSCI China ETF (MCHI-Q).

Their performance has lagged specialized ETFs focused on China’s consumers, including Global X MSCI Consumer Staples ETF (CHIS-A), which is up by about 40 per cent year-to-date. (It too is made up of a blend of different shares.)

Ms. Tan says advisors who are seeking more direct exposure to China’s markets should consider actively managed funds.

“While there are a couple of ETFs that focus on A shares, their liquidity can be tight,” she says.

Indeed, mutual-fund firms are beefing up their attention on China. Fidelity, for example, recently increased the number of analysts covering China to 11.

Ms. Tan, who manages Sun Life Excel China Fund, says active management is beneficial as it can help mute the volatility endemic to a Chinese market still dominated by fickle retail investors.

Despite its risks, China deserves consideration as a single-country allocation in portfolios like the U.S. and Canada.

Advisors who create individual stock portfolios could, for example, allocate 10 per cent of capital to a handful of Chinese stocks through ADRs or over-the-counter stocks, Ms. Tan says. These could include China’s largest insurer, AIA Group Ltd. (AAGIY-OTC-US), and internet firms Alibaba Group Holding Ltd. (BABA-N) and Tencent Holdings Ltd. (TCEHY-OTC-US).

Benoit Poliquin, president and lead portfolio manager at Exponent Investment Management Inc. in Ottawa, prefers this strategy. His clients only own one company: China Mobile Ltd. (CHL-N). He says it best represents the scale of opportunity in China.

“As its population becomes much more urban, for example, the amount of people you can leverage from a cellphone network is quite high,” Mr. Poliquin says.

He adds that many Chinese consumers use cellphones on second-generation wireless networks and are upgrading to more costly cellphones that operate on the more advanced fourth- and fifth-generation wireless networks, which should increase the company’s profitability.

Advisors have several ways to help investors gain exposure to China, which has a long runway for future growth, Ms. Tan says.

“The key risk is its markets are still young,” she says. “So, you need to be patient and invest gradually as opportunity arises.”

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