Turnover on the Shanghai and Shenzhen stock exchanges fell 32 percent year-on-year from January to June. In addition, China's economy grew 7.8 percent during the first half of the year compared to 9.6 percent growth in the same period in 2011, marking the slowest growth rate recorded in more than three years.
Further, only 360,000 retail broker accounts were opened in July, less than half of the 790,000 accounts opened in the same month last year. At the beginning of September, the Shanghai Composite Index dropped to lows not seen since the height of the global financial crisis in February 2009.
As individual investors in China's stock markets are finding it increasingly difficult to make satisfactory returns in such a challenging environment, investment in overseas funds offers a way for higher profits than can currently be obtained through domestic investment vehicles.
Risk Tolerance Should Determine Fund Choice
Choosing the type of offshore fund to invest in depends on the risk that an investor is willing to take.
Cautious investors can choose to invest in low-risk funds that ensure that their initial investment remains secure at the price of giving up potential growth. Investment in low-risk funds that protect initial capital is also a wise choice when stock markets are overvalued or to protect gains that have been already made from other funds. Investment in low-risk funds can also help balance an investor portfolio if paired with higheryield, more riskier investments.
Safe choices among offshore funds include deposit funds, which preserve value, while providing returns in line with bank deposit rates. Currency reserve funds are another option for cautious investors, as they offer small rates of returns, while protecting fund share prices. Investors can also choose to invest in bond funds, which offer capital growth over the longer term by investing in fixed interest securities that are issued by government and major companies.
Medium-risk funds offer a potentially higher level of return than low-risk funds, but they can achieve greater-than-average market movements due to investment in assets that can undergo a higher degree of price change, which are typically stock assets. This also means that investors may not get back the amount they invested. Medium-risk offshore funds include index-tracking funds, which aim to mirror the performance of a particular stock market index as possible, typically by purchasing shares of every company included in an index.
Higher-risk funds offer the opportunity to achieve very high levels of return over the long term. These high-yield funds typically focus on specific sectors in stock markets or investments denominated in different currencies, therefore they encounter high levels of fluctuation because of market movements. Higher-risk funds typically invest in assets belonging to higher risk markets, especially assets associated with emerging economies.
Balanced funds offer some security with the potential for long-term income growth. The value of balanced funds can go down as well as up, though.
Types of Funds
There are many different types of funds to choose from.
Open-end funds issue as many shares as investors demand and have no limit to the number of investors or the amount of money that they hold. Closed-end funds issue a set number of funds, after which the funds are traded through brokers in a similar way to stock. Closed-end funds trade on regular stock exchanges, letting investors buy and sell shares whenever the market's open and have diversified portfolios of underlying assets.
As closed-end funds have a limited number of shares, supply and demand play a larger role in determining their price than they do for other types of funds. Popular closed-end funds can trade at large premiums to their net asset value per share, while those that are out of favor can trade at substantial discounts. This makes it possible to make large gains or losses from trading in shares of closed-end funds. Closed-end funds are a viable option for investors because they can trade at significant discounts or premiums to the net asset value of their portfolios and closed end fund managers have more freedom to use leverage to boost returns.
Equity or stock funds invest in a diverse set of portfolios from different companies and industries. Depending on their investment straggles, some many only invest in large companies while others invest only in particular industries. There are also stock funds that will only invest in particular sectors, such as health and telecommunications offering the investor a diversified investment into a particular industry.
Bond funds invest in a diversified portfolio of fixed interest securities, for example government bonds and corporate bonds. The securities within the fund will give the investor an income from the coupons, or interest, that is paid out. Funds that invest in government bonds are generally considered to be less risky than funds investing in corporate bonds. However, rates are not guaranteed.
Balanced funds have the advantage of investing in a mixture of stocks and bonds. It is common for a balanced fund to have the majority of the portfolio invested in a mixture of these assets, with the remainder held in other asset classes such as property and cash. However, this varies depending on the objective of the fund. It is important to be aware of the split between stocks and bonds to fully understand the risks and rewards inherent within a particular balanced fund.
An emerging market fund invests in less developed countries that might, potentially, have a very high economic growth. Examples are Brazil, Russia, India and Malaysia. This high growth potential may be due to a number of factors, such as political and structural changes in a country, for example privatization; liberalization of trade or better access to capital. The main risks on the other hand are political instability and higher reliance on external capital. The financial markets in these countries can fluctuate quite dramatically.
Global funds offer a convenient solution to achieve a geographically diverse portfolio, as they invest in a variety of assets from across the world. Index funds have portfolios that are constructed to match or track the movements of an index in a particular financial market.
Index funds typically outperform actively managed funds, provide diverse market exposure, have lower operating expenses and have a low portfolio turnover.
Exchange traded funds are index funds that trade like stocks on a stock exchange. Exchange-traded funds typically have no minimum investment amounts, although they do have brokerage costs. Unlike index funds that can typically only be traded at the closing price on the day that a trade is placed, exchange traded funds can be traded throughout the day as long as stock markets are open. However, individual investors have to pay brokerage commissions each time they buy or sell exchange-traded funds. Hedge funds are a suitable investment choice for high net worth individual.
Hedge funds take significant risk with their investments by purchasing derivatives (a security based on a contract between two or more parties specifying conditions under which payments will be made) or by shortselling (selling securities or other financial instruments with the intention of buying them back at lower prices). In comparison with mutual funds, hedge has much higher risk, higher fees, are not subject to the same regulatory scrutiny and have lower returns.
Investment in US Money Market Funds a Safe Option
Investment in US money market funds is a safe option for investors who are risk averse. Retail money funds, which are offered primarily to investors, are proving increasingly popular among investors. US retail money funds saw growth in the week ended September 19 as total retail money market funds' assets increased by $1.88 billion over the previous week, climbing to $888.73 billion.
Select US Stock Funds Offer Superior Returns
Investors who are willing to take risks can also invest in US stock funds, which are doing similarly well and have now surpassed pre-financial crisis levels. In January 2008, individuals and institutions invested $12 trillion in US stock funds. At the park of the crisis in December 2008, holdings in stock funds were down to $9.6 trillion, a 20 percent drop. By the end of July this year, however, institutions and individuals had placed $12.3 trillion in stock funds. In addition, the average return from US stock funds in the third quarter of this year was 5.3 percent, bringing the year-to-date gain of US funds in the first nine months of the year to 12.9 percent.
Currently, the top performing US stock fund is the Oceanstone Fund, which only invests in US growth stock. The fund has posted an average return of 47.2 percent over the past four years and seen its assets grow from $752,500 to $26.5 million. Yet another high performer is the Matthew 25 Mutual Fund, which saw an average return of 51.4 percent over the 12 months ended September 30, and 32.8 percent from the start of 2012 through September. Meanwhile, the Buffalo Micro Cap Fund has returned 48.1 percent in the past 12 months, and 26.8 percent from the beginning of the year until September 30. In addition, as of September 30, the Hotchkis & Wiley Mid-Cap Value Fund, was up 47.2 percent over the past 12 months and 24.4 percentso far in 2012.
Fund that invest in gold have gained the most returns over the past four years: the Van Eck International Investors Gold Fund has gained an average 22.2 percent a year since 2008 while the Tocqueville Gold, at 21.9 percent a year.
Technology funds have also made large gains, with Apple driving most of the gains in the sector. The Berkshire Focus fund has gained 19.5 percent a year over the past four years by betting on technology stocks. Similarly, the ProFunds Internet UltraSector Inverse fund recorded an average return of 18.3 percent over the past four years.
US Bond and Hybrid Mutual FundsGaining More than Equity Funds
Among other mutual funds, it is best to invest in bond funds or hybrid funds (funds that invest in both stocks and fixed income securities), rather than stock funds. During the week ended September 12, investors pulled an estimated $2.75 billion from funds that invest in US stocks, marking the eighth consecutive week that investors have withdrawn money from the funds, according to the latest statistics from the Investment Company Institute, the national association of US investment companies.
In contrast to equity mutual funds, bond funds attracted $8.11 billion in estimated inflows, up 54 percent from the $5.28 billion they took in the week before. Of the $8.11 billion, $6.80 billion went to taxable bond funds with the remaining $1.31 billion going to municipal bond funds. Hybrid funds were also winners, taking in an estimated $1.31 billion, up 43 percent from the $910 million they drew in in a week earlier.
US Closed-End Funds Also Offering Hope to Investors
As US interest rates are likely to remain low until 2014, investors are more likely to gain more from investing in closed-end funds.
Closed-end funds have picked up recently with 15 new closed end funds, which raised $6.8 billion, established between January 1 and August 31. In comparison, only 17 new closed-end funds were established in the whole of last year.
UK Funds Slumping in the Face of Incoming Legislation
Individual investors in the UK are pulling out of UK funds, as a number of new laws are being implemented across Europe. As such, direct investment in EU funds may become a less attractive option to Chinese investors who can do so in light of the regulatory measures EU funds are being barraged with.
The US Foreign Account Tax Compliance Act, the European Union's Alternative Investment Fund Managers Directive and changes to the EU's Undertakings for Collective Investment in Transferable Securities regime are some of the regulations that EU funds have to grapple with. These regulations will increase the compliance burdens of EU-based fund managers, driving up EU funds' management fees and in so doing make them less attractive to global investors.
The US Foreign Account Tax Compliance Act, which was enacted in March 2010 and will be phased in starting on January 1, 2013, is a law that aims to ensure that US citizens pay all appropriate taxes. In order to do this, the act will impose a 30 percent withholding tax on payments from the US to non-US financial institutions. To escape the withholding tax, non-US financial institutions will have to disclose income and interest payment information about its US account holders who have accounts worth more than $50,000.
"The fund administration industry is facing an unprecedented volume of regulatory change over the next two to three years. Compliance with new regulation is global in reach and will be costly," Fracis Jackson, the head of Emea, JP Morgan Worldwide Securities Services, said in a statement in early September.
In addition, EU countries are in the process of implementing the Alternative Investment Fund Managers Directive, which is required to be made into law by all Eurozone countries by July 2013. The aim of the directive is to create a comprehensive and effective regulatory and supervisory framework for investment fund managers in the EU. The law affects all EU hedge funds, private equity funds, venture capital funds, real estate funds and investment trusts, among other investment vehicles. Bank, hedge fund and private equity fund managers have warned that the rules are unworkable, overstep the European Commission mandate and would drive up costs for investors.
Fund managers are further anxious because of proposed changes to the EU's Undertakings for Collective Investment in Transferable Securities (Ucits) regime, which is a set of directives that allow funds that comply with the directive to operate freely throughout the EU on the basis of a single authorization from one member state. Ucits funds are regulated and easier-to-trade alternatives to hedge funds.
The EU Commission released a proposal to revise Ucits regulations that affect, among other things, Ucits funds' depositaries. Currently, EU rules stipulate that the responsibilities of Ucits funds depositories include monitoring that funds adhere to investment restrictions and calculating net asset values for funds. Under the proposed changes, depositories would have greater potential liability for the actions of fund managers, which would increase the costs passed on to fund managers.
All these regulations are being felt by fund managers as investors pull out their funds from UK funds. According to the Investment Management Association, the total number of open-end UK fund shares sold to investors fell in August of this year, amounting to £23.2 million ($37.6 million), compared to £1.2 billion ($1.9 billion) in August last year.
Investors in UK funds are pulling their funds from risky stock funds, with net outflows of £604 million ($978 million) from equity funds reported in August, the biggest outflow since November 2011. Bond funds remained the best-selling asset class, gaining inflows of £518 million ($839 million).
This is not surprising as the top performing funds in the UK are mostly bond funds. At the beginning of August this year, the top-performing fund in the UK was the GLG Global Corporate Bond Fund, which has achieved a 107 percent cumulative return for its investors over the last five years as of July 31. The Fund primarily invests in bonds from across the world. Holding data for this fund is unavailable.
Another top performer was the Investec Emerging Markets Local Currency Debt Fund, which posted a 106 percent cumulative return over the past five years as of July 31. The fund invests in public sector, sovereign and corporate bonds issued in emerging markets, with its top three holdings in government bonds issued by Brazil (6.10 percent of its portfolio), government bonds issued by Turkey (5.66 percent of its portfolio) and government bonds issued by Russia (3.47 percent of its portfolio).
The M&G International Sovereign Bond has done similarly well, with cumulative returns of 102 percent over the past five years as of July 31. The fund invests mostly in sovereign debt securities, with its top five holdings in bonds issued by Norway (10.42 percent of its portfolio), bonds issued by Germany (9.60 percent of its portfolio) and US treasury notes (1.75 percent of its portfolio).
It is important to note, however, that investing in UK funds is recommended for investors who are looking for long-term investments, as the short-term gains from UK funds has been lackluster.
China Domestic Alternative to Offshore Investing: QDII Funds
The Chinese government launched the QDII scheme in April 2006 as a means to drain excess liquidity from domestic securities markets, as oversupply of cash in the Chinese economy was leading to inflation and upward pressure on asset prices. The QDII program was also designed to give Chinese financial institutions the opportunity to gain greater experience with, and from, overseas investment, while providing new investment options for Chinese citizens.
The QDII program allows approved financial institutions to invest their clients assets in overseas markets, bypassing China's otherwise stringent foreign exchange regulations. The financial institutions are given a quota of money that they can invest in overseas financial products. Each QDII product has its own minimum investment requirements.
Chinese regulators have been approving an ever-increasing number of QDII applications and have slowly increased the total QDII investment quota in recent years. As of September 3, the total QDII quota stood at $84.3 billion, with 101 financial institutions having the ability to invest abroad. In comparison, when the scheme was introduced in April 2006, the total QDII quota amounted to $14.2 billion. The continuing expansion of the scheme gives Chinese investors increased opportunities to diversify their investments outside of the mainland and indicates the government willingness to gradually liberalize offshore investment restrictions.
Investors have been wary of QDII funds because many lost money in offshore funds during the financial crisis in 2008 and they still believe there is risk associated with investing in overseas markets.
The bullish outlook of US stock markets and the accompanying potential for high returns should make investors reconsider investing in QDII funds, however. Xue Tian, the fund manager of the Chang Xin S&P 100 QDII fund, noted that although there is instability in overseas markets and risks remain, the American economy is steadily recovering and its markets offer the best investment option available to global investors at present. Xue added that, in comparison, there is a slump in the Chinese economy, there are intensifying risks posed by unrest in emerging markets and the debt crisis means investing in Europe poses a large risk to investors.
In addition, QDII funds have shown the most growth among all types of funds offered in China, making them one of the best investment options in the country at present. China Galaxy Securities statistics show that the 66 QDII funds offered in China had risen by over 4 percent from the beginning of the year until September 14. In contrast, over the same period, closed ended funds had an average net growth of 0.51 percent year-onyear, hybrid funds grew 1.17 percent, equity funds grew 1.14 percent and money-market funds grew 2.88 percent. Meanwhile, the Shanghai Composite Index fell 3.26 percent over the same period.
QDII Index Funds Offer High Returns on Investment
QDII funds have been doing well because they have been boosted by the recovering US economy. QDII funds that track indices that are composed of blue-chip companies have been performing particularly well, including the Guotai NASDAQ-100 Fund and the Chang Xin S&P 100 Fund, which invest in stocks of some of the world largest companies by market capitalization.
The Guotai Nasdaq-100 Index Fund was the first mainland fund to track the performance of an overseas index when it opened for subscription in March 2010. The fund tracks the Nasdaq-100, a stock market index of the 100 largest companies listed on New York's Nasdaq stock exchange. The weighting of companies included in the fund is based on the total market value of their outstanding shares and the companies that the fund invests in include Apple Inc, Baidu Inc, Googl, Intel and others. The US-based State Street Corp., one of the world's leading providers of financial services to institutional investors, is the global custodian to the Guotai Nasdaq-100 Index Fund, while China Construction Bank, the country's third largest commercial bank, acts as local custodian for the fund. At the close of trading on September 19, the Guotai Nasdaq-100 Fund had grown 22.72 percent year-on-year and 11.59 percent over the past three months.
The Chang Xin S&P 100 Fund has also posted impressive gains. The fund, which was launched in April 2011 and tracks the S&P 100 index of 100 US stocks with large market capitalizations, recorded year-on-year growth of 19.67 percent at the end of trading on September 19 and growth of 10.88 percent over the past three months
Gold QDII Funds Offer Superior Returns
Gold prices are rising as Japan, US and European central banks have embarked on stimulus measures. These stimulus measures have made gold more attractive to investors who want to use investments in gold as a hedge against inflation. Gold prices hit their highest level in six-and-a-half months on September 19, with spot gold trading at $1,799.10 by 2.56 pm. The rise in gold prices has led to increases in the value of funds that focus on gold trading. The China Universal Gold and Metal Fund, which invests at least 90 percent of its assets in gold-backed exchange-traded funds and metal-backed securities, had risen 9.02 percent month-onmonth as of September 19.
The China Universal Gold and Metal Fund manager Liu Zilong said that gold prices would probably continue to rise over the long term because of the continuing threat of inflation.
Considering the increase in precious metal prices, investing in gold QDII funds is a worthy investment to consider.
Investing in Funds a Wise Choice
Regardless of whether they are offshore bond funds or domestic QDII funds, good funds are among the best investment vehicles available because of the diversity they offer, the little attention they require and their potential for returns over the long term. Funds are a superior way for a person to invest in a broad variety of investments without having to buy each individual security. Chosen carefully, mutual funds can help create and grow wealth for years to come.
