China Portfolio Insurance
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China Portfolio Insurance
Exploring Investment Opportunities in China with Safety Nets
China presents significant investment opportunities, but the risks involved can be daunting. Here’s how to embrace China’s growth prospects while safeguarding against potential losses.
Historical Perspective
China has dominated the global economy for eighteen of the past twenty centuries. Today, it's on a path to reclaim its leadership in Asia and challenge U.S. global dominance. However, sustaining a 10% growth rate, addressing rural discontent, transitioning to a market-based financial system, and moving towards greater openness and democracy are monumental tasks. While I'm skeptical about achieving all this seamlessly, China's industrial strength and the ambition of its people could offer substantial returns.
Investing in China
I recommend investing in China with caution, recognizing the speculative nature of such investments. Here’s a simple strategy to maximize gains while mitigating risks:
1. Invest in China’s Broad Market:
- Consider the China iShare Exchange-Traded Fund (FXI), which includes 25 of the largest and most liquid Chinese stocks listed on the Hong Kong Stock Exchange?"some from mainland China (H shares) and others from Hong Kong (red chips).
- Recently, the China iShare has increased by over 12% this year.
- It offers exposure to energy (20%), telecom (19%), and industrial sectors (18%). However, remember that most of these companies remain largely government-controlled.
2. Hedging with Put Options:
- Secure your investment by purchasing a put option on the China iShare (FXI). This gives you the right to sell shares at a predetermined price on a set date.
- Although paying a premium may seem like an additional cost, it’s similar to having home or life insurance, offering peace of mind against potential market downturns?"especially in risky emerging markets like China.
Practical Examples
- China Scenario:
- Purchase 100 shares of China iShare (FXI) at $62 per share, totaling $6,200.
- Buy a put option allowing you to sell FXI at $60 by January 2008.
- This strategy limits potential losses to $2 per share plus the premium cost, approximately $500. Alternatively, a $50 strike price reduces the premium to about $200, limiting losses to $12 per share plus the premium.
- Latin America Example:
- Invest in the Latin America 40 iShare (ILF) at $113 per share, for a total exposure of $11,300.
- Purchase a put option to sell at a $100 strike price in March 2006, costing around $300.
- This limits potential losses to 15% while retaining unlimited upside potential.
Conclusion
When investing in emerging markets like China, it’s vital to remain composed and cautious. These investments should only constitute a small portion of your portfolio, and whenever feasible, hedging strategies should be employed to manage risks effectively.
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