Posts Tagged ‘equities’

There is a difference between investing in China and investing in China’s growth. This is a careful distinction that a lot of investors fail to make, yet it is a necessary one if one is seeking to profit from the undeniable growth that the Chinese people are expected to enjoy in the years to come.

Investing in China

The act of investing in China is the same as investing in domestic companies. The process involves narrowing down a large field of potential companies and ideas to a handful of prospects and then digging even deeper to determine whether that company meets fundamental basics to earn your investment.

These fundamentals would include such things as an appropriate equity level, satisfactory growth rates, margins and so on. The key difference is that such companies are actually based in China, so our everyday experience with them would be virtually non-existent (compared to investing in, say Wal-Mart or Ford or Apple, etc.).

Another key disadvantage to investing in foreign companies is that most people are unfamiliar with their political alliances, which becomes increasingly important in countries like China. To make an investment in a Chinese company, one should understand their political standing and how that bodes for their future growth and sustenance.

Investing in China’s Growth

In contrast to the above, investing in China’s growth is quite different. This involves taking positions in domestic companies that have the potential to profit from China’s growth. For example, companies that outsource key manufacturing processes would fall into this category. Such companies will be able to reduce their cost of goods sold (manufacturing costs) since labor in China is at a discount to domestic labor.

Another example would involve companies that are positioned to enjoy part of the expected growth in the middle class. This class historically creates a deeper demand for certain products and services, such as discretionary and luxury goods. Companies that have been allowed to establish a presence in China obviously stand to benefit from this and could offer great investment potential as well.

Summary

It is unquestionable that China is set to enjoy an aggressive growth rate in the years to come. Positioning one’s portfolio to take advantage of this growth is a little more complicated — does one invest directly in companies that have little relevance domestically and operate in a foreign political climate, or does one invest domestically in companies that have taken the steps necessary to enjoy part of this aggressive growth?

As often happens, the question becomes one of risk tolerance and investment knowledge. Knowing that there is a difference between the two surely helps.

When we look at the recent popularity of bank stocks, it is evident that a lot of people will get burned. The recent run up has resulted in higher volatility, which means that just as quickly as things have risen, they will drop. And up until the point that the prices really start to head south, someone will keep buying up these “popular” bank stocks. Everyone except the mutual funds who, for the most part, know better that to get sucked into the popular investment strategy when things rise, they will only keep rising.

Taking a contrarian investment approach like those we discussed elsewhere on this site might help.

Or it might not. After all, financial services firms remain relatively unpopular unless we are talking specifically about the “big banks,” the same stocks and companies that burned people in the past. But not all financial services firms are created equally. People who want to know where to invest their money might do well to examine the smaller firms, like those where Ivy Small Cap Value fund invests.

After all, our recommended Ivy Small Cap Value Fund has rewarded investors with a 13.39% return YTD.

Evidently, the folks at Ivy are doing something right, yet in their top 25 holdings you will not find any Citigroup, AIG, Fannie/Freddie, et al. holdings. Not a single one of them. In fact, they invest a large chunk of their assets in Small-cap stocks… not large, not Giant. (To a lesser extent, they invest in Medium cap securities, but as a small cap focused fund, they are pretty keen on sticking to their small-cap guns.

Given that less than 4 months of the year have passed, a 13.39% return (as at April 9, 2010) is pretty respectable. They know where to invest, no doubt about that, especially when it comes to investing in financial services firms. So, for those investors who have enjoyed the volatility rise and continue to pour money into some of these unsupported (fundamentally anyway) financial services firms, don’t let yourself get burned. Invest in a mutual fund that pays the pros to put your money where it belongs — in the right firms.

Growth funds are something of a sub-asset class when it comes to your overall asset allocation model. In most cases, growth funds are part of the equity holdings, but depending on your income class profile there could be a growth component to the income class as well. In the case of the income glass, growth will normally come from investing in higher-risk bonds or discounted bonds. These bonds will experience growth in periods of declining interest rates or at maturity when the bonds mature at face value.

In most instances, growth will come from capital appreciation in the value of an equity security, most often a stock. And this is typically how equity class growth funds operate – they will hunt for equities that have demonstrated long-term growth trends or potential. In many cases, growth funds will target stocks in high growth fields such as technology, bio-technology and developing technologies. However, since such industries are often speculative, so too can the investments be speculative.

As such, growth funds can be further categorized into sub-categories such as Large Cap Growth Funds which will invest primarily in securities that have a large market capitalization. These types of growth funds will have a slightly different approach and often a less aggressive investment objective. In most cases, the securities owned by the fund will be larger companies (such as Apple in the case of technology or General Electric in the case of emerging technologies) with strong balance sheets and heavy investments into longer-term, emerging technologies.

In some cases, growth funds will be “laser-focused” on an industry or sector. In the example above, this could mean the technology industry or, in less generalized terms, say the water-purification technology industry. This means that the fund might invest in a blend of large or small cap equities.

And in some cases still, some fund managers will target growth regions of the world. In the latest market bubble, many funds jumped on the “BRIC” nations which showed tremendous growth potential. These nations were Brazil, Russia, India and China. Even after the economic slowdown, many funds remain invested in these regions because of their perceived growth potential.

In other cases, growth funds will take a more general approach and simply invest in equities that show growth potential. In such cases, the fund can diversify across all market capitalization areas as well as across the different industries and sectors and geography. Normally, such broadly focused growth funds are larger mutual funds that merely aim to exceed the index performance.

Generally, growth funds make up a special area of the equity class of investments. Their primary focus is capital appreciation through growth rates that are expected to be greater than growth in other industries/sectors, similarly sized market-capitalized equities, or different geographical areas. Determining what makes a smart growth investment is often a subjective task that relies rather heavily on the skill and astute observations of a keen portfolio manager or analyst.