Taking the Templeton Basket to China

 | Feb 22, 2012 | 2:30 PM EST
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A couple of weeks ago, I discussed one of the greatest trades that was put on by the late, great Sir John Templeton back in 1939, when Europe's political climate was wreaking havoc (sound familiar) on the stock market.

Instead of trying to focus on one or two winning investments amidst all the uncertainty, Templeton instead created a basket investment. He bought $100 (about $1600 in today's dollars) of every single stock that traded below $1 on both the NYSE and ASE. Templeton ended up investing in 104 companies, 34 or so of which were bankrupt. Four years later, Templeton cashed out making nearly four times his money.

Fast forward today and I think the same trade exists in China. Many Chinese-based, US-listed Chinese small caps are trading at valuations that, on the surface, look undeniably cheap. The reason? Investors do not trust the financial reporting coming out of many of these businesses. I think that in all probability there are some fantastic gems in between all the other companies that may turn out to be duds. While some businesses may turn out to be frauds, China is not a fraud. It's merely a different nation governed by its own set of rules that plays a role in how businesses are run. We in the US may not be comforted by the Chinese approach, but it needs to be mutually respected. And if there is opportunity, there needs to be a way to exploit it.  

Enter the Templeton China Basket trade.

Just like Templeton, investors may want to buy a handful of these companies, perhaps allocating 0.25% to 0.5% per position and building a 5% position among 10 or 20 such names. I've looked at some of these names closer than others and I've attempted to sift through the ones that look completely outrageous. But in the end, the basket approach is just hoping to pick up a couple of home runs that will more than make up for several potential strikeouts.

All 10 names look incredibly cheap. No doubt, some may turn out to be value traps. Renren is actually a Chinese listed ADR that many consider the Facebook of China. The basket comprises businesses that sell food, fertilizer, auto parts, industrial equipment and copper. These are all things that China needs in massive quantities for many years to come. 

I will check up on this basket from time and track its performance and see how it does. Remember that Templeton's trade took four years to make him 300%. It's always nice to make a quick buck, but given the widespread awful reputation that these securities currently have, it may take a little time for that attitude to change.

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