What China's Currency Reform Means For Investors

Why a stronger renminbi will help U.S.-based investors.

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The Chinese government's move to allow its currency, the renminbi, to appreciate against the dollar provided a big boost for U.S. stocks as investors expressed their confidence that American companies will be able to gain a firmer foothold in China's notoriously protective economy. Specifically, China's weak currency has propped up the country's exporters, while at the same time making imports costly. With the Chinese government's decision, which was announced over the weekend, to officially begin strengthening the renminbi, Chinese consumers will be better able to afford foreign goods, including those produced in the United States.

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But even as shareholders in domestic companies celebrate, questions linger about how currency reform will affect a different class of investors: those who have their money in U.S.-based mutual funds that invest in the Chinese stock market. On one hand, a stronger renminbi can help the Chinese government stave off inflation and allow the country's consumer base to expand. But at the same time, it's possible that certain segments of the Chinese economy, particularly the country's exporters, could take a short-term hit as a result of the weakened currency.

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Still, the prospect that the Chinese economy may not undergo a seamless transition hasn't quelled the enthusiasm of U.S. mutual fund companies who have their money invested in China. So what are they so excited about? For U.S.-based investors, one of the bigger benefits of the currency reform is that it will make their holdings more valuable. That's because their profits from the Chinese stock market, which are originally collected in renminbi, are then converted back into U.S. dollars. A stronger renminbi means that they will get more out of the conversion.

"For a dollar-based investor, those earnings are going to become more valuable," says Edmund Harriss, a comanager of the Guinness Atkinson China and Hong Kong mutual fund (symbol ICHKX). Or, as Jeff Tjornehoj, Lipper's research manager for the United States and Canada, puts it: "Another way of saying it is the U.S. dollar will decline against Chinese currency, and that will help U.S. investors. When the dollar declines against another currency, the value of your fund appreciates."

James Oberweis, a comanager of the Oberweis China Opportunities fund (OBCHX), says any short-term stumbling blocks in the Chinese economy will be "more than offset" by this conversion advantage. Still, he expects the benefits to be modest in the near term, particularly since the Chinese government hasn't given any indication that it will allow significant appreciation.

"It's a positive. Is it a big positive? It would be a big positive if we had big appreciation. We're not going to get that right away. But we might over a period of a few years," he says. In other words, he says that the current currency movements for the most part represent a "symbolic" gesture. "It could be indicative of things to come, but the type of appreciation that they're likely to permit in the short run is rather modest," he says.

Harriss, for instance, doesn't expect the renminbi to appreciate against the dollar by more than 2 to 3 percent before the end of 2010. "I don't expect there to be a major move this year," he says.