Portfolio Manager Perspectives

Jeff Benjamin

AlphaShares fund offers China play — without the fireworks

Covered strategy reduces volatility in Chinese markets by two-thirds, says portfolio manager Jonathan Masse

Dec 14, 2009 @ 4:52 pm

By Jeff Benjamin

The major pros and cons of investing in China could be summed up as growth and volatility.

But Jonathan Masse, senior portfolio manager with AlphaShares LLC, believes the growth is worth the ride.

“We're big fans of the China story because that's where most of the growth is, but that growth does come with volatility,” he said.

An AlphaShares analysis of the Chinese stock market's volatility makes the U.S. market look like almost smooth by comparison.

Last December, for example, when the Chicago Board of Options Exchange Volatility Index spiked to more than 80, the AlphaShares China Volatility Index was hovering around 122.

A volatility index is generally viewed as a gauge of fear in the markets, and the historical average of the U.S. index is 21.

“Our most stressful day is like an average day in China,” Mr. Masse said.

AlphaShares seeks to dampen the extreme volatility that comes with investing in China with its Green Dragon Fund LP, a hedge fund that employs a covered-call strategy.

The fund holds 51 Chinese stocks through a combination of the Hang Seng Index and the FTSE/Xinhua China 25 Index.

The volatility of the fund is reduced by two-thirds through the sale of call options, Mr. Masse said.

“We are giving up some return with this strategy, but we're also dampening the volatility,” he said. “If you like money, and you like to sleep at night, this is a good strategy for you.”

This year through November, the strategy had gained 49%, net of fees, which compared to a 54.4% gain by the combined underlying indexes.

In 2008, when the combined underlying indexes fell by 47.3%, the fund lost 25%.

“We like to tell people it's like China on training wheels,” Mr. Masse said.

Of course, not everyone can gain access to hedge fund strategies, like the Green Dragon, but Mr. Masse said most investors could stand to add some exposure to one of the world's fastest-growing economies.

“We think the average equity investor is grossly underweight China and if you're underweight China, you're underexposed to the majority of the world's growth,” he said.

The MSCI All Country World Index, for example, provides just 2% exposure to China, a country that has been growing at 10% a year for the past two decades.

Mr. Masse recommends an allocation to China of between 5% and 10%.

The Chinese economy, which is expected to grow by about 9% next year, will likely benefit from government efforts to diversify away from a strong reliance on exports and to develop more internal economic growth through its expanding middle class.

One way for retail-class investors to tap in to China's economy is through the Claymore/AlphaShares exchange traded fund (YAO), a modified market-cap-weighted fund that offers broad exposure to large and small Chinese businesses.

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives .


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