China funds not for faint-hearted

Several readers have written to ask about the performance of China funds in general and Excel China Fund in particular. I’m not surprised. The Canadian and U.S. stock markets have been bad but China’s has been horrendous. It’s as if a pin were stuck in China’s balloon as soon as the Olympics ended and it has been deflating ever since.

Over 12 months to November 30, almost every mutual fund that invests in China and related markets such as Taiwan and Hong Kong is down more than 40 per cent. The list is scary: AGF China Focus Class down 49 per cent, BMO Greater China Class off 52.9 per cent, Fidelity China B down 43.6 per cent, Investors Greater China B off 45.9 per cent, and on and on. It’s a veritable financial disaster zone!

Excel China was the worst of the group by a narrow margin, with a loss of 54.5 per cent. It’s no wonder that investors in this and other China funds are wondering whether to hold on or bail out. The answer depends on whether you are a short or long-term investor.

No one doubts that China is on the way to becoming an economic superpower. But there are always bumps in the road of economic ascendancy and the country has hit a big one. It seems unlikely China will slip into recession but a dramatic slowdown in the growth rate is almost as bad. So in the short term, there may be more downside in Chinese-related stocks.

When the world economy recovers – and no one knows when that will be – China will be back at the forefront of growth and its stocks will soar. But at this point, owning units in any China fund is a risky proposition. If you are already in such a fund, you may want to grit your teeth and hang on. But I would not recommend buying more until the world economic situation stabilizes.

As for Excel China specifically, investors need to understand the basic strategy. Whereas most China funds hold the bulk of their assets in large-cap securities listed on the Hong Kong Exchange, the Excel managers take a different approach. The Hamon Investment Group (which handles 90 per cent of the portfolio) focuses on small to mid-cap stocks listed on mainland China exchanges. As a result, the fund has large holdings in China B shares. These are shares in companies incorporated in China that are traded on the Shanghai and Shenzhen markets.

Those exchanges were especially hard-hit this year and the damage was compounded by the fund’s exposure to the Taiwan market, which also experienced a sharp decline. So by its nature, this fund will tend to be more volatile than China funds that are more oriented to Hong Kong. That means it may have more upside potential but there is also more downside risk. You have to decide if you’re willing to live with that.

If you do decide to stick with China, do not put any of these funds into a registered plan, like an RRSP or RRIF. Keep them in non-registered accounts so that if things get even worse and you want to bail out you will at least be able to claim a capital loss which can be used to offset any capital gains you have in 2009 or in the three previous years. (Losses can also be carried forward indefinitely.)

Talk to a financial advisor before making any decisions and be sure you understand the risks. There is a lot of profit potential in China but as we have seen, a great deal of danger as well.

Gordon Pape’s new book is Tax-Free Savings Accounts: A Guide to TFSAs and How They Can Make You Rich. Copies can be reserved now at

Photo © David Franklin