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Random walk to China

INTERVIEW: Moira O'Neill talks to Dr Burton Malkiel, the legendary Wall Street investor and leading advocate of the efficient market hypothesis, about the prospects for investing in China

Watching China host the Olympics has confirmed Dr Burton Malkiel's belief that investors should have much greater exposure to China. "It was very difficult to watch the opening ceremony without getting the view that Chinese companies have arrived on the world stage. I've never seen anything so spectacular." He is looking forward to a further important symbol in two years time, when Shanghai is putting on the World Expo 2010 trade fair.

The American economist is the author of the classic investment book A Random Walk Down Wall Street and a leading advocate of the efficient market hypothesis. Now chief investment officer for AlphaShares, an investment management firm dedicated to providing investors with strategies and products that allow them to participate in China's economic boom, he has written another book, From Wall Street to the Great Wall, which sets forth a grand strategy, including sample portfolios, for investing in China.

Investors in China who had their fingers burnt in the past year may not be watching the Olympic games with as much enthusiasm as Dr Malkiel. And the economics professor has a sobering dose of reality for them: "It's been a disastrous year; the declines were staggeringly large, but this is unfortunately in line with historical precedent". History, according to Dr Malkiel, shows the Chinese stock market is the most volatile in the world - even compared with other emerging markets such as Brazil, which is notoriously volatile.

Continuing the history theme but on a brighter note, Dr Malkiel says a variety of valuation matrices show that Chinese stock markets are attractive as they've ever been: PE multiples have fallen to approximately world levels and growth rates of earning are might higher in Chinese companies. "If you use the PE Growth rate, Chinese companies look extraordinarily attractive relative to the US and Europe," he enthuses.

Naturally, he won't be drawn on predicting when the Chinese stock market will recover. "Drops of this magnitude have never occurred but I'm not telling you this is the bottom of the market." After all, this is the man who claims never to have met anyone who can successfully time the markets - either in his early career on Wall Street or in his later academic career.

The importance of exposure to China is filtering through to most investors but the questions of how and how much to invest are more difficult. This is what Dr Malkiel's new book sets out to answer.

How much exposure?

Most investors have a home country bias but Dr Malkiel emphasises that you should be internationally diversified. "I drive a Japanese car, have a Korean TV, wear Scottish Shetland sweaters, and have all sorts of stuff made in China," he says.

When calculating the right exposure to China he starts with the world indices - in which China represents 1-2 per cent, (Hong Kong companies, for example, represent 1.67 per cent of the S&P Global 1200 index). "But China has 5 per cent of the world's GDP and if you adjust for purchasing power it's 10 per cent of GDP," he says. "And then China is responsible for 30 per cent of the world's GDP growth."

Throw in the Big Mac index compiled by The Economist - "A Big Mac is $3 in New York, $4.5 in London and $1.31 in Shanghai" and China is looking like it ought to be a bigger chunk of an investor's portfolio because its currency is so undervalued.

"If you think of an economy that is 10 per cent of the world and 3 per cent of the world's growth - and will be more of the world's growth next year because Europe is slowing down and the US could have negative growth in the last quarter of 2008, then I think investors ought to ask themselves why they don’t have 10 per cent of their equities in China."

But Dr Malkiel says he doesn't know anyone who has this level of exposure. "Even among sophisticated institutions people are underweight in China," he says.

So does he follow his own advice? Yes. "I have more than 10 per cent of my portfolio in China."

How to invest

Dr Malkiel's book recommends a mixed investment strategy that includes direct investments in Chinese companies. However, he also recommends multinational companies that get most of their growth from China. "They have more transparent accounting and are less risky than direct Chinese shares."

For example there is a US company called Yum! Brands, the parent of KFC and Pizza Hut. "They have been fairly stagnant in the US but are growing at 20 per cent a year almost entirely because of China, where they are opening 1-2 stores a day," says Dr Malkiel. In China they also have a chain of Chinese fast food restaurants called East Dawning.

His indirect portfolio includes giant commodity producer BHP Billiton. "The Chinese have a voracious appetite for new materials," he says. "I prefer commodity producers to commodities. You have companies that are making money and paying dividends. I think people will do better with the producers."

Dr Malkiel also likes luxury leather goods brand Louis Vuitton. "The Chinese are brand conscious. Louis Vuitton sells more genuine (and I stress genuine) handbags in China than in the whole of Europe."


For most individual investors, Dr Malkiel believes that exposure to China through funds is the "only practical way". He is a huge fan of exchange traded funds (ETFs).

For example, the Barclays iShares FTSE Xinhua 25 gives exposure to large Chinese companies including the big banks and petrochemical companies. However, he is not keen on the larger cap Chinese indices as they are dominated by financial and oil companies with a lot of government ownership. This has two potential problems.

The first he illustrates with this example: "Take the example of a near bankrupt state-owned enterprise that employs 10,000 people and comes to a part-government-owned bank for a loan. The banker's hat says 'you're not credit worthy' but the government hat says 'people are out of work - we may have riots in the street - better make the loan'." He admits this is oversimplifying the issue and "we in the US should not be smug about banks", but it illustrates his point succinctly.

The second downside of large Chinese companies is something called the 'overlay problem', caused by China's programme to convert non-tradable shares held by the state into free-floating shares tradable on the stock markets. "The Chinese are very convinced that capitalism works," he says. "They understand that they need to distribute shares into private hands. But if government shares are put on the market it can't be good for the market."

For these reasons, in the ETF arena, he prefers funds that track small Chinese companies. "The nice thing about small companies is they are likely to have less government ownership and be less in financials and oil companies, and more in consumer stocks," he says. He also likes Chinese real estate: "Chinese real estate companies have huge land banks that they control and are now selling at discounts to value of the land banked."

And if you're still not convinced, here is a staggering statistic: "China has over 100 cities with a population of over one million. It's adding big cities every few weeks. To put this in proportion, we have 10 cities in the States with a population over one million."

His company, in partnership with Claymore Securities has launched two funds that give US investors easy exposure to these two areas: The Claymore/AlphaShares China Small Cap Index ETF (AMEX: HAO) and The Claymore/AlphaShares China Real Estate ETF (AMEX: TAO). Unfortunately, there aren't yet any equivalent ETF offerings for UK investors.

Dr Malkiel's book From Wall Street to the Great Wall was published in January 2008 and is out in paperback in December 2008. You can buy it for £11.21 (a 34% discount), along with other Malkiel writings, in the IC bookstore.

For more on Dr Malkiel, see and

For more on investing in China generally, see