China’s Next Chapter

The fund also puts more emphasis on health-care companies than the index. Stimulated by government aid, the spending on health care in China has increased 15% to 20% a year over the last decade. Life expectancy increased from age 66 to age 76 from 1980 to 2011, creating more demand for health-care services, which rising incomes are giving aging seniors and other people more money to pay for.

In addition to emphasizing different sectors than the index, the fund puts more of its muscle into small and mid-cap stocks. Its expense ratio of 1.08% is significantly lower than that of most actively managed China funds.

With the fund’s unique profile, its performance can differ significantly from that of its peers, which tend to hew more closely to the index. From 2009 through 2011, the fund outperformed the average China-focused fund in Morningstar’s database by a significant margin. But with consumer stocks lagging financials for most of the last couple of years, the fund’s more recent performance has been less impressive. Nonetheless, Morningstar analyst William Samuel Rocco noted in a report that the fund is “one of its category’s standouts. … Rough spells are facts of life for even the most elite offerings, and there are ample grounds to be optimistic about this fund’s long-term potential.”

The turnover ratio is just 6%. Gao is clearly a patient investor who takes a long-term view of the fund’s holdings. One of them, Sino Biopharmaceutical, is a leading maker of hepatitis and cardiovascular drugs. Unlike many pharmaceutical companies in China, which focus on producing generics, Sino has its own research and development capabilities and a number of strong products in its pipeline.

A top fund holding, Tencent Holdings, is a leading technology company that is leveraging its 800-million subscriber instant messaging platform to promote its chat services, e-commerce, social networking and online gaming capabilities. While Tencent’s valuation is fairly high, Gao believes it is capable of 30% to 40% annualized earnings growth.

The fund’s consumer plays include China Mengniu Dairy, China’s largest producer of milk, yogurt, ice cream and other dairy products. With a 25% share of China’s dairy market, the company is well positioned to feed the country’s growing appetite for dairy products.

In the financials sector, Ping An Insurance Group, the country’s second-largest insurance company, is entering new areas of business such as banking and investments. Gao says its management team is capable of turning the company into a successful financial conglomerate that will serve the needs of China’s growing middle class.