China needs a more contrarian investment strategy

October 29, 2009

The Chinese may be big admirers of Warren Buffett, but two recent examples show that even the most sophisticated Chinese investors don’t follow the Sage of Omaha’s method. They tend to pay too much attention to Mr. Market and spurn the value-based strategy advocated by Buffett.

China’s sovereign fund, CIC, acts like a momentum trader. This year it has been doing deal after deal, trying to chase a rising stock market. Last year it mostly sat on its hands though its strong cash position would have allowed it to scoop up assets on the cheap.

In another example, Chinese regulators stopped approving mutual funds which invest in global equities 17 months ago. After a dramatic run-up this year, they decided that now is the time to go abroad again and resumed approval of those funds, though bargains are much less likely to be found now.

There are reasons why Beijing acts in this way. The government is worried about how  foreign investment plays with the public in an economy where a large proportion of the people remain extremely poor and the welfare system is patchy. Lending to wealthy westerners, or investing in Wall Street firms run by billionaires is controversial. Contrarian investments tend to attract more attention than those that follow the herd. Only steely-nerved politicians and officials welcome that sort of exposure.

Chinese investors are also perhaps still too inexperienced to be hard-nosed value
investors. This may change over time as it did with the Japanese. Shaking off their old image of being indecisive and pro-cyclical, the Japanese surprised observers by snapping up shares in famous names such as Morgan Stanley <MS.N> during the crisis at prices that now look like a bargain.

Of course, momentum investing hasn’t been a unsuccessful strategy so far this year, as global markets have rallied sharply. But CIC should not be complacent. The jury is still very much out. In most cases CIC has committed to lock-up periods and bought shares with less voting rights, so it is not that easy to exit some of the big plays it has made. If markets weaken, CIC may find itself locked into these investments for the long haul. The still sceptical Chinese public might be even more unforgiving if that happens.

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