Going to a Digital Extreme in China

In its shift toward a consumption-driven economy, China has been embracing digital technology at rates that dwarf those of many developed countries. The Chinese have been scooping up smartphones, accessing the internet and consuming goods from online retailers at an incredible pace. We believe the world needs to quickly adapt to China becoming a major player in the digital marketplace, as this trend is in the early stages of exciting growth.

See how consumption patterns have changed.

Only a few mobile phone owners in China are using smartphones today, but the country is quickly closing that gap. As you can see below, the smartphone penetration as a percentage of total mobile phone users is lower than that in the U.S. In 2012, smartphone devices made up only a little more than 10 percent in China; in the U.S., they comprised 35 percent.

However, the smartphone market is one of the fastest growing sectors in China these days. This year, 3G smartphone users are expected to double to 300 million people, which is equivalent to every single resident in the U.S. owning a smartphone!

And the country’s smartphone trend is early in adoption: Penetration in 2013 is estimated to be only 23 percent of mobile users, versus 40 percent in the U.S., says CLSA.

Accelerating smartphone penetration in China should benefit handset component suppliers

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With a growing use of smartphones, “mobile web is the best way to reach users,” says CLSA. While the number of users with regular internet access in China has been rising substantially, after iOS and Android became available in 2009, mobile internet adoption has gone vertical. This is 4.5 times faster than internet users, according to Lee Kai-Fu, one of the pioneers who helped proliferate the internet in China in the late 1990s. If the trajectory maintains its course, mobile internet users should soon surpass the number of users on traditional formats.

Mobile Internet adoption 4.5x faster that regular internet in China

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This skyrocketing use of the internet is one of the driving forces that is “powering consumption,” especially in the e-tail industry. According to McKinsey Global Institute, China is already the world’s second-largest e-tail market. Since 2003, the market has had an annual growth rate of a whopping 120 percent!

You can see a snapshot of this tremendous industry in McKinsey’sanalysis of online retail sales. According to a sample of Chinese cities in 2011, apparel, recreation and education, and household products are “the three largest online retail segments in China,” says McKinsey.

Among 266 cities representing more than 70 percent of online retail sales, the share of online consumption in apparel reached 35 percent. Recreational products, including consumer electronics, books and tickets took a 20 percent share of online consumption. Household products such as appliances and furniture had a 15 percent share.

Online Spending in Sample of Chinese Cities in 2011

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However, online retailing is only in its infancy in China, with its future perhaps “more impressive,” says McKinsey. The research firm estimates by 2020, the e-tailing industry may “generate $420 billion to $650 billion in sales.” If growth continues at its current pace, “China’s market will equal that of the United States, Japan, the United Kingdom, Germany, and France combined today.”

With more Chinese owning smartphones, having access to the internet and buying online, Michael Ding, portfolio manager of the China Region Fund (USCOX), believes there are tremendous business opportunities opening up beyond online shopping, including online games, online search, online advertisements, and many other internet applications.

The China Region Fund, which invests in regional sectors exhibiting top relative strength, has benefited from an allocation to information technology in recent months. We believe this has helped the fund outperform its benchmark Hang Seng Composite Index (HSCI) this year, with the fund increasing 6.70 percent and the HSCI rising only 0.50 percent as of May 31, 2013.See the industry breakdown of the fund now.

Total Annualized Returns as of 3/31/13
One-Year Five-Year Ten-Year Gross Expense Ratio Expense Ratio After Waivers
China Region Fund 3.06% -4.90% 11.18% 2.66% 2.55%
Hang Seng Composite Index 11.95% 2.17% 14.84% NA NA

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

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