Best Portfolio Insurance Offers in China

Are you excited about the upside potential of China but can’t pull the trigger due to the significant drawback danger? Here is a way to invest in China growth and still sleep at night.

China has been the biggest economic climate in the globe for eighteen of the past twenty centuries and it is clearly determined to regain its role as the hegemonic energy in Asia and then challenge U.S. global leadership. Will it be able to sustain its 10% economic growth rate, quell rural discontent, build a sound market-based financial system, privatize dominant state-owned enterprises and move towards openness and democracy? This is a tall order and you can put me in the skeptic line.

Nonetheless, China’s raw industrial power, energy as well as the palpable ambition of the Chinese people could realistically produce a giant return. I advise my clients to go ahead and invest in China but emphasize that this is a speculative investment. It is smart to protect against the considerable downside risk.
Here is a easy plan you may desire to perform to capture the upside while cutting your losses if the Chinese economy strikes a speed bump.

Initially, you could take a wide risk in China through investing in the China iShare exchange-traded fund (FXI) that is comprised of 25 of the largest and most fluid China names. All of the 25 stocks included in the China iShare are detailed on the Hong Kong Stock Exchange. Some of them are incorporated in mainland China (H shares) and some of them are incorporated in Hong Kong (red potato chips). The China iShare has been picking up steam in the last few months and is up just over 12% so far this year.

The China iShare provides great exposure to three key sectors of China: energy (20%), telcom (19%) and commercial (18%). This concentration can be seen as a plus or a minus depending on your perspective. For example, some smart investors are placing a bigger bet on China’s consumer markets.

The top five companies represent 40% of the index. The annual operating expenses of the China iShare are only 0.74% compared to 2% plus for various other options out there including actively managed China and greater China regional funds. Keep in mind that most of these companies are still largely controlled and owned by the Chinese government.

Next, you could take out some insurance to protect this place by buying a place choice on the China iShare (FXI). It sounds complicated but is actually very straightforward. An option is a right to buy (call) or sell (put) 100 shares of a security on a fixed termination time at a set price (strike cost). For this right an investor pays a fee or premium.

While you may grumble about paying the advanced with cool tough money when you could not need it, you probably have house insurance just in situation catastrophe hits and no question you have some life insurance as well. Why not protect your portfolio because well? It is especially important to consider hedging against more risky emerging markets such since China. While countries like China offer tremendous upside potential, the downside risk can be daunting and immobilize even the bravest investor.

Let’s look at a couple of examples. Say you get 100 shares of the China iShare (FXI) which is exchanging at $62 per share. Your total exposure is $6,200. Then purchase a put option (right to sell the China iShare) that gives you the proper to sell FXI at a price of $60 on the 3rd Friday in January 2008. I think we all can agree that a lot could happen to China, good and bad, from now until January, 2008.

If the price of the China iShare moves down toward the strike price, the value of the option will increase.
This will cost you a premium of a little over $500 but limits your potential loss to $2 per share plus the advanced. Or buy a put option at a strike price of $50 and your premium falls to about $200 with a worst instance scenario of a loss of $12 per share plus the premium.

Here is another example. You know Latin American markets are hot and think the bull market will continue but are wary that there is the potential for a razor-sharp pullback. You could buy 100 shares of the Latin America 40 iShare (ILF) providing you publicity to Brazil, Argentina, Mexico and Chile at a cost of $113 for a complete exposure of $11,300. Then get a put option providing you the right to sell 100 shares at a strike price of $100 in March 2006 for a premium of around $300.
Your worst case scenario would then be a loss of 15% with unlimited upside.


Keep a cool mind when investing in emerging market nations like China.
They should represent only be a little part of your portfolio and, whenever feasible,
take over some insurance.

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