Is China really the best place to invest?

One of my major focuses is demonstrating that so much of the "conventional wisdom" of investing is wrong. One of the more persistent beliefs held by investors is that if you want high returns, you should invest in countries experiencing rapid economic growth.

It seems that even professor Burton Malkiel, author of A Random Walk Down Wall Street, believes the conventional wisdom, as he has been touting China as the place to invest. For example, in 2011, he stated: "Institutional investors are missing out on investing in the world's fastest growing economy; since the early 1980s China has expanded at more than 9 percent a year, after inflation." To see if the conventional wisdom is correct, let's take a look back.

Antti Ilmanen, in his book Expected Returns, reports that from 1993 through 2009, China's GDP growth rate averaged more than 10 percent. If ever there was a test that would demonstrate that high rates of economic growth translate into high investment returns, this should have been it. Yet, Ilmanen found that U.S. dollar-based investor would have earned negative returns over the period. The negative return has now been extended to 19 years as the iShares Trust FTSE China 25 Index Fund (FXI) returned just 2.1 percent in 2010, and then lost 17.7 percent in 2011.

If the Chinese example doesn't convince you that the conventional wisdom is wrong, perhaps the cumulative weight of the evidence from the following studies will: One study found that for the period 1900-2000, the real return from stocks and a country's growth rate was negatively correlated (-0.27); another study ranked 83 countries and found that the lowest growth countries outperformed the fastest growing countries by almost 7 percent a year.

The explanation is pretty simple: Markets price for risk, not growth. Countries with high projected growth rates are perceived as less risky than those with low projected growth rates. Thus, you shouldn't expect high returns from countries with high growth rates.