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Guinness Atkinson Asia Brief

February 2005
Edmund Harriss
Fund Manager Asia Focus Fund, China & Hong Kong Fund

China – The Opportunity of a Lifetime

Our long term view on China is that the economy, which has grown on average by 9% a year, will sustain a growth rate of around 8% for the next 20 years. This view is based on the process that is now underway where years of infrastructure investment, deregulation and reform have given rise to a buoyant manufacturing sector. This has resulted in raising the standard of living for millions of people and creating wealth. We have not seen anything on this scale since the early days of American industrialization at the end of the 19th century and beginning of the 20th century.

The wealth effect generated by mass-industrialization has created a middle class that has increased from 18 million households in 1991 to 50 million households in 2002. By 2010 that number is estimated to reach 100 million households, or 25-30% of the population. As a comparison, a middle class of 30% of the population equates to the position of America in the 1950s.

A more balanced economy with growing wealth and an expanding consumer society creates a more stable outlook in the short, medium and long term. There are still many challenges ahead, the most pressing being the reform of the financial system without which China’s progression will run into the sand. The good news is that the problem is receiving immediate attention. Under the terms of China’s entry into the World Trade Organization it must open the financial sector fully to foreign companies by 2007. So there is no vague plan – China is working to a schedule.

Investors were worried in the first half of 2004 that an engineered economic slowdown would result in a bust just as it did in the late 1980s and again in the mid-1990s. On both occasions growth was very unbalanced and depended entirely on investment growth. Inflation exceeded 20%. Fast forward to 2003 and we see again another period of rapid investment but we also see a much more balanced economy. Value-added industrial output has been growing strongly and consumption is buoyant with retail sales growing over 10%. Equally significantly, in this ‘boom’ inflation peaked at 5.3% and is now down below 2.5%.

Source: BNP Paribas

Our job at Guinness Atkinson is to navigate through this period of rapid growth. Not all sectors grow in the same way at the same time. Some sectors attract heavy investment and then need to take time to digest; during which time those share prices do not perform well. At present the mid-stream industrial sectors such as steel, cement, aluminium and some petrochemicals have seen too much investment. Extra capacity should lead to pricing pressures and we are cautious on those stocks. The auto manufacturers, both foreign and local, have also been very aggressive investors. By contrast the commodity producers still see strong structural demand that should support product prices. Similarly, manufacturers of finished goods for export as well as for domestic consumption are still doing well.

The Guinness Atkinson Asia Focus Fund and China & Hong Kong Fund invests in foreign securities which involves greater volatility, political, economic and currency risks and differences in accounting methods. The Funds are non-diversified meaning they concentrate their assets in fewer holdings than diversified funds. Therefore, these Funds are more exposed to individual stock volatility than diversified funds.

This information is authorized for use when preceded or accompanied by a prospectus for the Guinness Atkinson Funds. The prospectus contains more complete information, including investment objectives, risks, fees and expenses related to an ongoing investment in the Funds. Please read the prospectus carefully before investing. Mutual fund investing involves risk and loss of principal is possible.

Distributed by Quasar Distributors, LLC (02/05).

For more information, visit www.gafunds.com.