During World War II, it was a common tactic of the Republic of China to nationalize the ownership positions of undesirable owners and turn their stock investments into $0 overnight while redistributing ownership interests between the Nationalist government and private citizen allies. This was a strategy advocated by Kung Hsiang-hsi (popularly known as Dr. H.H. Kung) to increase the likelihood of victory in the Second Sino-Japanese War. Since 2009, American stocks have performed exceptionally well, and the regular trumpet to invest in foreign stocks has been silenced in response to such extended American outperformance (of course, value investors would see this as a contrarian indicator and treat the underperformance of European stocks as an opportunity).
But for most of the early 2000s, you often heard the conventional wisdom suggest that American investors ought to invest in the Asian growth markets (that argument is not necessarily true—you could do more than fine with a portfolio of Visa, Nike, Disney, and Becton Dickinson). Investing in Asian countries could be wise, but most commentary lacks the historical perspective that Asian markets have been unfriendly to foreign and minority (I use minority to mean unsympathetic to the ruling government in this context) investors during periods of wartime.
Personally, I would prefer to invest primarily in the United States, Great Britain, Switzerland, and Australia, given the long records of governments respecting and protecting ownership positions (interestingly enough, Thomas Jefferson once remarked that America would remain a sovereign power as long as property rights were adequately protected, and James Madison saw the protection of minority, unpopular freedom as the secret ingredient to long-term success). I prefer to merge the concepts and look at how well countries treat the property rights of the most unpopular minorities to determine whether the government infrastructure provides suitable soil for investment.
As far as Chinese investing goes, I would much prefer to own a block of Yum! Brand Shares rather than investing directly in something like Asian Fund. Not only are you able to avoid ongoing expenses (in the case of actively managed mutual funds that invest primarily in Asia, it’s typical to pay around 1.4% annually so that a $10,000 investment would pay over $1,400 in fees over a ten-year period when factoring in the added expenses that would accompany capital appreciation). Plus, I would much prefer some kind of coverage in the very unlikely event that foreign stakeholders see their investment get nationalized.
That’s why I would much prefer to invest in something like Yum! Brands to find safe exposure in China. American investors are familiar with Yum! Brands through their flagship Pizza Hut, Taco Bell, and Kentucky Fried Chicken franchises. China accounts for 53% of their revenues—America is second-fiddle in their business model. The risk-reward scenario with something like Yum! Brands is highly favorable—if you want to tap into Chinese growth, you can: Profits grew from $0.71 per share in 1998 to $3.20 at the end of 2014, and together with the dividend that got initiated in 2004, amounted to compounding of 16.01% annually so that a $8,600 investment in Yum! Brands in 1998 transformed into over $100,000 at the end of 2014.
You also get downside protection in the event that something unthinkable happens to the portion of profits that come from China. If something happened that caused those Chinese profits to disappear, Yum! Brands would transition from becoming a company that makes $1.4 billion into a company that makes $700 million. Certainly not fun for shareholders, but you would survive in a worst-case scenario. Instead of seeing your capital completely wiped out, you would see the dividend cut in half, profits cut in half, and you’d likely encounter a depressed stock price that went down by more than half as these sort of stock market events tend to lead to irrationality in the stock price. That’s much better protection than 100% wipeout in a worst case scenario.
That strikes me as the most intelligent way to build an estate: You ask yourself, “What do I seek to accomplish?” And then you take steps to accomplish that goal while protecting yourself on the downside. In this case, you seek to accomplish Chinese investing. With Yum! Brands, you are able to grow profits at north of 10% annually as the company is becoming a large fast food purveyor in China. But you are also protected on the downside, as the company would still be about half as profitable if China simply disappeared from Yum! Brands’ balance sheet. Adding these kinds of redundancies to your investment choices can mean the difference between grinding towards your goals in bad times and having to go back to zero.
Originally posted 2015-04-22 19:11:41.