Is China really the best place to invest?

(MoneyWatch) 

One of my major focuses is demonstrating that so much of the "conventional wisdom" of investing is wrong. One of the more persistent beliefs held by investors is that if you want high returns, you should invest in countries experiencing rapid economic growth.

It seems that even professor Burton Malkiel, author of A Random Walk Down Wall Street, believes the conventional wisdom, as he has been touting China as the place to invest. For example, in 2011, he stated: "Institutional investors are missing out on investing in the world's fastest growing economy; since the early 1980s China has expanded at more than 9 percent a year, after inflation." To see if the conventional wisdom is correct, let's take a look back.

Antti Ilmanen, in his book Expected Returns, reports that from 1993 through 2009, China's GDP growth rate averaged more than 10 percent. If ever there was a test that would demonstrate that high rates of economic growth translate into high investment returns, this should have been it. Yet, Ilmanen found that U.S. dollar-based investor would have earned negative returns over the period. The negative return has now been extended to 19 years as the iShares Trust FTSE China 25 Index Fund (FXI) returned just 2.1 percent in 2010, and then lost 17.7 percent in 2011.

If the Chinese example doesn't convince you that the conventional wisdom is wrong, perhaps the cumulative weight of the evidence from the following studies will: One study found that for the period 1900-2000, the real return from stocks and a country's growth rate was negatively correlated (-0.27); another study ranked 83 countries and found that the lowest growth countries outperformed the fastest growing countries by almost 7 percent a year.

The explanation is pretty simple: Markets price for risk, not growth. Countries with high projected growth rates are perceived as less risky than those with low projected growth rates. Thus, you shouldn't expect high returns from countries with high growth rates.

[Locke99100]

Larry,

The only reason I have doubts about your assumption, is that Harvard and Yale have moved a good percentage of their funds to China and India. Swensen, in particular, has done really well in China. I know that Yale has beat index funds in China with superior active management that the rest of us don't have access to, but there must be something working over there for some investors.

[Ddogley]

Hi Larry
Could you name the two studies you refer to please?
Many thanks

[LarryswedroeCBS]

Dodgely
Antti Illmanen did the recent one on China and can be found in his great book Expected Returns.

The others can be found in Credit Suisse Global Investment Yearbook

[rightbehind]

We should be locking the door behind any company that offshored manufacturing. I have nothing against the Chinese people. I do have have a problem with neocon republicans looking to place themselves at the head of table. If a company wants to sell a product here it should be made here or it gets taxed. Those rules work for every nation.

[twisi]

@ rightbehind, and we should tell those terrible corporations they have to unionize and the government should make sure the unions own the bonds and all the stock in corporations as obama did with those greedy neocon republicans that loand money to GM and Chrysler in the form of buying their bonds. Then Big government should make sure all real Americans buy only from those unionized corporations and not from those evil nonunion un American corporations.Better yet make all corporations comply with the union Bosses and the union Bosses can make more than their current multimillion dollar pay checks because they just wont let you work if you don't give part of your pay to them so they can make even more millions. What would really make the economy work would be to centralize are government and let the government decide what work we do and what union we will join because without the union card you can't buy food, housing or better yet not even get healthcare because we all need to understand a hungry man is an obedient man and that way all those greedy neocon republicans don't get all those big corporate jobs. Wouldn't it be nice to know we don't have to educate our children? just let the government chose how much education our children get and what job they will have when they finish with mandatory military service. That way if you are friends with the fuhrer your kids can get the big corporate jobs.

[LarryswedroeCBS]

rightbehind
Sorry to disagree. If you did that the world would be a much worse place. This is basic economic theory of comparative advantage. Each country should produce things they are RELATIVELY (not absolutely) more efficient at. When that is done the world maximizes wealth. Each nation is better off.

Now that doesn't mean that one should not have rules that include fair trade. That is different subject

Best wishes
Larry