Nick Giambruno is helming the Crisis Investing letter for Casey Research now, which must come with a fairly high degree of attention because Doug Casey really made his name with his bestselling book of the same name in the late 1970s (later revised a couple times).
And after all this time you know what you’re going to get with Doug Casey, who has been a pretty consistent and strong-voiced libertarian: He thinks government has far outlived its usefulness, that we’re on the brink of a catastrophic collapse (and have been, at least much of the time, since 1979), and that you need to embrace “alternative” investments to protect yourself. Presumably those “alternatives” have morphed somewhat over the years, but gold has almost always been a factor, as has foreign real estate and investment in foreign countries — he’s very well-traveled, and many of the anecdotes that crop up in ads for Doug Casey’s work revolve around buying deeply discounted companies or real estate in countries that are hated or avoided by most investors.
Doug Casey has spent the past few months opining in interviews that we’re leaving the eye of the financial hurricane — that the first waves hit with the financial crisis of 2008, we’ve been enjoying the becalmed eye, and now the back end of the hurricane is going to hit us harder still. Here’s how today’s ad quotes Casey, from March:
“Right now, we are exiting the eye of the giant financial hurricane that we entered in 2007, and we’re going into its trailing edge. It’s going to be much more severe, different, and longer lasting than what we saw in 2008 and 2009.”
That’s a lovely metaphor, and it makes sense that there would be a negative backlash, eventually, to the huge monetary stimulus programs of the past eight years — particularly from inflation, though that hasn’t yet reared is head, but probably also from the great imbalances and strange incentives that have been created by holding interest rates at zero (or, most absurdly, by negative rates).
But the timing of big turns in the economy is, obviously, easy to opine about and almost impossible to accurately forecast. Doug Casey was saying much the same thing, about a likely “exit from the eye of the hurricane” within months back in the Spring of 2014. And he wasn’t alone, people have been predicting disaster pretty much every year since the US Government and the Federal Reserve stepped in in 2008 and 2009 with their various “rescue” programs and set us on the “easing” and stimulus path. The Fed has done unprecedented things in pushing liquidity, and is obviously the major global driver of investor sentiment these days — as we can see every time (including last week) that a hint of possible rate hikes hits the ears of Wall Street traders.
So even when we think that a pundit is making a rational argument, it’s important not to nod your head so vigorously that you forget to be skeptical about their ability to accurately predict the future.
And, like I said, we know the prevailing sentiment — they put it in the first couple paragraphs of the ad letter:
“As Dispatch readers know, America has been in decline for decades. The 2008-2009 financial crisis only accelerated the country’s downfall, thanks to the Federal Reserve.”
There is quite clearly another way of looking at America’s progress over the past few decades, but debating the point is not why I’m writing to you. Instead, I thought we’d try to identify for you what Casey’s analyst Nick Giambruno is pitching as his play on this “Biggest threat no one is talking about.”
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And Giambruno notes that his readers are already “prepared for this coming crisis” because they’ve stockpiled cash and sold most of their US stocks, and because they own gold.
But this particular hinted-at recommendation is a buy based on the “major economic event” of a new superpower being born… here’s a bit more from the ad:
“With America in rapid decline, China will soon become the world’s biggest and most important economy. And it could happen faster than most people think….
“Like Doug, Nick is a contrarian. He likes to buy assets other investors hate. This simple approach often gives you the chance to buy world-class businesses for cheap.
“According to Nick, China is one of the most hated markets on the planet right now. Investors are worried about its slowing economy… a potential property bubble… and China’s volatile stock market….
“Nick thinks China’s long-term potential far outweighs these risks.”
So what did Nick find on his trip to China “in search of opportunities?”
Apparently, in his June issue of Crisis Investing he covered what he calls the “new silk road,” which is “all about tying Eurasia together with infrastructure… high-speed rails, modern highways, fiber optic cables, energy pipelines” and etc. He calls this “new silk road” a “direct threat to U.S. global supremacy” and a “huge opportunity for investors.”
So what should those investors buy? More from the ad:
“‘A-shares’ are shares of Chinese companies that trade in mainland China. If MSCI adds A-shares to the Emerging Market index, China’s weighting could jump from 2.7% to 20%.
“In other words, money could soon start pouring into China’s mainland stock market.
“Nick found a way to profit before China opens its flood gates…”
Huh, so this is a little bit like Dr. David Eifrig’s pitch about REITs a couple weeks ago — he argued that more money would flood into REITs because of MSCI’s sector rebalancing, which would force more institutional money to flow into that investment class… and Giambruno is saying much the same thing, with the implication that as China’s domestic share markets become more open, global investors will have to add more China exposure or risk being “underweight” a major part of the global indices.
And at that time, Eifrig hinted at a couple REITs he thought people should buy — but also really implied that buying a REIT ETF would work out well. So what’s Giambruno saying? Does he want us to buy some specific Chinese companies that trade mostly on the domestic market?
Not really — he’s got a fund in mind. Here are the hints:
“He recommended a fund that offers direct exposure to the New Silk Road. It holds a company that builds bridges and toll roads… a major Chinese railroad… and a company that’s bankrolling many ‘Silk Road’ projects.
“Best of all, this fund is easily accessible. It trades on the New York Stock Exchange.”
And some financial metrics that we can check:
“… this fund is trading at a 15% discount-to-liquidation value.”
“Nick’s China investment has already returned 15% since June.”
There are now some ETFs that track the Chinese domestic “A Share” market, those have slowly rolled out over the past few years as that market has opened up a little bit to foreign institutional investment (you still really can’t, as an individual US investor, go and buy individual stocks on the Chinese exchanges… other than Hong Kong, which is a separate beast entirely and is much more tied into global markets)… but Giambruno clearly isn’t talking about one of the ETFs, because they don’t generally trade at significant discount or premium prices to the value of the indexes they cover and the stocks they own.
No, if you’re talking about trading at a discount, particularly if that discount is persistent and not just the result of a day’s shock, then you’re talking about Closed End Funds. Which means, sez the Mighty, Mighty Thinkolator, that Nick Giambruno’s China fund investment is the Morgan Stanley China A Share Fund (CAF).
A few years ago, CAF was a bit of an odd bird — Morgan Stanley got special permission to create a limited fund of these stocks, so when this closed-end fund went public in the mid-2000s it was really the only way that US investors could get access to A Shares stocks in China on the Shanghai or Shenzhen exchanges. When enthusiasm for China was high, the fund traded at a huge premium to the NAV of the stocks it owned; when enthusiasm waned, it often traded at a steep discount. That’s the way of all closed-end funds, they are effectively leveraged investments because they trade not just on the value of the underlying investments, but also on the sentiment that drives investors to either oversell or overbuy that particular sector… and since that was the only fund available for a while, it was crazier than most.
Now, things have settled down somewhat and there are probably about a dozen ways to invest in the A Shares segment of the China market through ETFs — the first ETFs started popping up in 2011 or so, and more new ones come out each year that follow either the A shares market or some subset or variation the domestic Chinese stock market (small caps, internet stocks, etc.). But even though all those ETFs pretty routinely trade within a few tenths of a percent of net asset value, CAF still trades at a substantial discount to NAV… it may not ever get to trade at a premium to NAV again like it has for a few brief moments in the past decade, but it could certainly return to a more “average” closed-end fund discount of 5-10% if investors are pleased by the fund’s performance and optimistic about the sector.
If we assume that you’re interested in having exposure to the domestic Chinese stock market, either because you think it will attract more institutional money as it opens up further to the world or just because you think the stocks will become more valuable over time, what should you do? Should you pay the lower expense ratio of an ETF and get a return that pretty much matches the performance of the index, or buy a fund that’s actively managed, costs more in terms of expense ratio, and trades at a discount?
Well, since the ETF that I most often check for this market was introduced in November 2013, the db X-trackers Harvest China ETF (ASHR), the NAV of that ETF and of the Morgan Stanley A Shares CEF (CAF) have followed almost exactly the same path… but that gives the edge to CAF, because it payed a substantially larger distribution last December so has had a stronger total return (a distribution cuts the NAV, as you would expect, since that cash is sent to shareholders and is no longer part of the fund). So the total return since November 2013 has been about 60% for CAF versus 30% for ASHR.
This year, the difference has been less stark — but a narrowing of the discount has helped CAF to do a bit better than ASHR since January 1 as well — CAF has lost 5% of its value, ASHR has lost 12%. Both have done quite well over the past few months, but that hasn’t been nearly enough to counter the huge swoon they took back in February, when pretty much all markets around the world were crashing.
There is likely to be more volatility for CAF than for the various ETFs that track Chinese domestic indices, not just because of the closed-end fund premium/discount variability, but because the fund is much less diversified. The top ten holdings of CAF represent make up about 68% of the fund, with near-10% stakes in China Resources Sanjiu Medical, Jiangsu Expressway, and Industrial and Commercial Bank of China… whereas the ASHR portfolio looks much more like a typical index ETF, with the top holdings being about 2.5% positions in Ping An Insurance, China Minsheng Banking, and Industrial Bank and the top ten holdings making up less than 20% of the fund. That’s good if the managers are particularly adept at choosing stocks, but it’s obviously risky if they make a mistake with one of those larger holdings.
No big surprises there, active management always provides a different (and higher) risk than indexed investment funds — but active management is also the only way to do better than the index, if that’s your goal (no matter how many academic papers and long-term studies tell us that seeking to beat the market is a fool’s game, we are all, at heart, fools in that regard… if you didn’t want to beat the market with at least some play money, you wouldn’t spend so much time researching stocks and investments).
So do you find the Morgan Stanley A Shares fund compelling? It has done well over the last few months, so it looks like Nick’s pick in June was certainly well-timed, at least in the short term… though the Hong Kong shares (usually referred to as “H shares”) of big Chinese companies have generally done better than the domestic A shares in recent months. The fund generally moves in sympathy with the broader Chinese domestic A shares index, but will certainly be more volatile than the index because of concentration, manager risk, and the natural leverage that CEFs often provide because of the swings in the premium or discount valuation. And yes, it trades at a big discount today — as of the last close, the shares were trading at about a 15.5% discount to NAV.
The fund often pays out large distributions, too, though you probably shouldn’t count on that huge distribution paid out last year being a regular thing (CAF paid out about a 30% cash distribution last December, ASHR paid out about 22% thanks to the big capital gains both enjoyed as the China market boomed for a while in 2015). Over the past few years, the management fee has been earned by CAF through index-beating performance (the annual management fee is about 1.6%, roughly twice as high as the expense ratio for ASHR), but who knows whether that will continue to be the case in the future. Morgan Stanley’s last semiannual report for the CAF fund is available here if you’d like to see it, it also includes the basic letter from the managers about their strategy and weightings.
And with that, I’ll leave you to your own musings — is the domestic China market likely to outperform the US market in the coming years, or do you have other favorite sectors for investment? Let us know with a comment below.