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China's Influence Felt Far and Wide

Funds need not be Asia-focused to have felt the impact this year.

Gregg Wolper, 10/25/2011

Concerns about China have hit that stock market hard in 2011.

A potential slowdown in that country's economy has frightened investors, even if China's growth rate would still hit levels most developed markets would envy. In addition, questions about the thoroughness and accuracy of the accounting of Chinese companies--concerns that aren't new but tended to be brushed aside when enthusiasm ran high--have come to the fore, particularly with Chinese firms listed in the United States and Canada.

The impact on funds has been widespread. It can even be felt in some areas most might not expect.

Hurting at Home
Funds in the China Region category have felt the impact most directly. It has suffered the worst average performance of Morningstar's 14 international-fund categories for the year to date through Oct. 21, with a loss of 24.4%. In a year that's been tough for many areas of the investment markets, that's the worst showing of any category, whether equity, bond, or alternative, domestic, or foreign.

Although, as noted above, there are good reasons why doubts have arisen about China, it's still a bit surprising the China Region category is sitting at the absolute bottom of the rankings in 2011. After all, it wasn't China that suffered a devastating earthquake, tsunami, and nuclear crisis. Nor is China at the forefront of the most serious ongoing financial crisis this year: the Greek debt fiasco and its real and potential impact on European banks and governments.

Perhaps China stocks, having recently been viewed as such a trendy play, were simply in position to suffer a greater fall. It's worth noting as well that China's dismal category ranking derives partly from fund-creation trends. Had fund companies not created so many China portfolios when that country's market was riding high, there wouldn't be a China Region category available to sit in last place. Conversely, it's safe to say that if enough suitable funds existed to create a Greece category, it would be doing worse than China Region. In any case, China funds have suffered even though most of them aren't limited to the Mainland. They can also invest in Hong Kong and, in some cases, Taiwan. But unfortunately for the funds, these markets have tumbled about as far as China's have this year. Indonesia, Malaysia, and Thailand have held up much better, but they're off-limits to this crowd.

Other Emerging-Markets Funds Also Feeling the Pain
That said, the effects of China's rough year have not been limited to China funds. Concerns about slowing growth in China also help explain certain other categories' travails so far this year. The second worst group, with a loss of 21.7%, is Latin America stock. Latin America fund portfolios are dominated by Brazil, and Brazil's market is heavily influenced by resource giants whose most influential customer is China. (There are also several Brazil-only funds in the category.)

Needless to say, the other Asia-focused categories have also been affected, but most interesting is how some funds have been hurt far more than others. Dreyfus Emerging Asia DEAAX, for example, is the worst performer in the Pacific/Asia ex-Japan category, with a staggering loss of 38.1%. A key reason: It has about one third of its assets in China versus just 14% for the category average. It's also overweighted in Taiwan. Meanwhile, that fund has much less invested than most peers have in South Korea, whose market has been much healthier than China's this year.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.
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