UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 811-05749
----------
THE CHINA FUND, INC.
(Exact name of registrant as specified in charter)
C/O STATE STREET BANK & TRUST
2 AVENUE DE LAFAYETTE, 6TH FLOOR
P.O. BOX 5049
BOSTON, MA 02206-5049
(Address of principal executive offices)(Zip code)
Copy to:
Mary Moran Zeven Leonard B. Mackey, Jr., Esq.
Secretary Clifford Chance US LLP
The China Fund, Inc. 31 West 52nd Street
2 Avenue de Lafayette, 2nd Floor New York, New York 10019-6131
Boston, MA 02111
(Name and Address of Agent for Service)
Registrant's telephone number, including area code: (888) 246-2255
Date of fiscal year end: October 31
Date of reporting period: October 31, 2006
ITEM 1. REPORT TO STOCKHOLDERS.
THE CHINA FUND, INC.
ANNUAL REPORT
OCTOBER 31, 2006
----------------------------
THE CHINA FUND, INC.
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
Key Highlights 1
Asset Allocation 2
Industry Allocation 3
Chairman's Statement 4
Investment Managers' Statements 5
About the Portfolio Managers 8
Schedule of Investments 9
Financial Statements 15
Notes to Financial Statements 19
Report of Independent Registered
Public Accounting Firm 25
Other Information 26
Dividends and Distributions;
Dividend Reinvestment
and Cash Purchase Plan 35
-------------------------------------
</Table>
THE CHINA FUND, INC.
KEY HIGHLIGHTS (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------------
FUND DATA
- --------------------------------------------------------------------------------------
NYSE STOCK SYMBOL CHN
- --------------------------------------------------------------------------------------
LISTING DATE JULY 10, 1992
- --------------------------------------------------------------------------------------
SHARES OUTSTANDING 14,496,220
- --------------------------------------------------------------------------------------
TOTAL NET ASSETS (10/31/06) US$455.2 MILLION
- --------------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE (10/31/06) $31.40
- --------------------------------------------------------------------------------------
MARKET PRICE PER SHARE (10/31/06) $30.40
- --------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------
TOTAL RETURN(1)
- --------------------------------------------------------------------------------------------------------------
PERFORMANCE AS OF
10/31/06: NET ASSET VALUE MARKET PRICE
- --------------------------------------------------------------------------------------------------------------
1-Year 49.64% 37.20%
- --------------------------------------------------------------------------------------------------------------
3-Year Cumulative 51.74% 13.88%
- --------------------------------------------------------------------------------------------------------------
3-Year Annualized 14.91% 4.43%
- --------------------------------------------------------------------------------------------------------------
5-Year Cumulative 217.46% 277.46%
- --------------------------------------------------------------------------------------------------------------
5-Year Annualized 25.99% 30.43%
- --------------------------------------------------------------------------------------------------------------
10-Year Cumulative 239.52% 270.39%
- --------------------------------------------------------------------------------------------------------------
10-Year Annualized 13.00% 13.99%
- --------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------
DIVIDEND HISTORY
- --------------------------------------------------------------------------------------------------------------
RECORD DATE INCOME CAPITAL GAINS
- --------------------------------------------------------------------------------------------------------------
12/21/05 $0.2172 $2.2947
- --------------------------------------------------------------------------------------------------------------
12/22/04 $0.1963 $3.3738
- --------------------------------------------------------------------------------------------------------------
12/31/03 $0.0700 $1.7100
- --------------------------------------------------------------------------------------------------------------
12/26/02 $0.0640 $0.1504
- --------------------------------------------------------------------------------------------------------------
12/31/01 $0.1321 --
- --------------------------------------------------------------------------------------------------------------
12/31/00 -- --
- --------------------------------------------------------------------------------------------------------------
12/31/99 $0.1110 --
- --------------------------------------------------------------------------------------------------------------
12/31/98 $0.0780 --
- --------------------------------------------------------------------------------------------------------------
12/31/97 -- $0.5003
- --------------------------------------------------------------------------------------------------------------
12/31/96 $0.0834 --
- --------------------------------------------------------------------------------------------------------------
12/29/95 $0.0910 --
- --------------------------------------------------------------------------------------------------------------
12/30/94 $0.0093 $0.6006
- --------------------------------------------------------------------------------------------------------------
12/31/93 $0.0853 $0.8250
- --------------------------------------------------------------------------------------------------------------
12/31/92 $0.0434 $0.0116
- --------------------------------------------------------------------------------------------------------------
</Table>
(1) Total investment returns reflect changes in net asset value per share or
market price, as the case may be, during each period and assume that dividends
and capital gains distributions, if any, were reinvested in accordance with the
dividend reinvestment plan. The net asset value per share percentages are not an
indication of the performance of a shareholder's investment in the Fund, which
is based on market price. Total investment returns are historical and do not
guarantee future results.
1
THE CHINA FUND, INC.
ASSET ALLOCATION AS OF OCTOBER 31, 2006 (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------
TEN LARGEST LISTED EQUITY INVESTMENTS*
- --------------------------------------------------------------------------------
1. Chaoda Modern Agriculture (Holdings) Ltd. 4.53%
- --------------------------------------------------------------------------------
2. Shanghai International Airport Access Product 3.75%
- --------------------------------------------------------------------------------
Shanghai Zhenhua Port Machinery Co. Ltd. Access
3. Product 3.08%
- --------------------------------------------------------------------------------
4. China Petroleum Access Product 2.86%
- --------------------------------------------------------------------------------
5. Far East Energy Corp. 2.73%
- --------------------------------------------------------------------------------
6. China Merchants Bank Co., Ltd. Access Product 2.63%
- --------------------------------------------------------------------------------
7. Xinao Gas Holdings, Ltd. 2.56%
- --------------------------------------------------------------------------------
8. Cathay Financial Holding Co., Ltd. 2.44%
- --------------------------------------------------------------------------------
9. Lenovo Group Ltd. 2.40%
- --------------------------------------------------------------------------------
10. Golden Meditech Co., Ltd 2.38%
- --------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
- --------------------------------------------------------------------------------
LARGEST DIRECT INVESTMENTS*
- --------------------------------------------------------------------------------
1. CDW Holding Ltd. 1.57%
- --------------------------------------------------------------------------------
2. Captive Finance, Ltd. 0.67%
- --------------------------------------------------------------------------------
3. teco Optronics Corp. 0.03%
- --------------------------------------------------------------------------------
</Table>
* Percentages based on net assets at October 31, 2006.
2
INDUSTRY ALLOCATION (UNAUDITED)
- --------------------------------------------------------------------------------
INDUSTRY ALLOCATION (AS A PERCENTAGE OF NET ASSETS)
(PIE CHART)
<Table>
Industrials 16.5%
Consumer 14.5%
Discretionary
Energy 12.3%
Information 11.6%
Technology
Financials 10.3%
Consumer Staples 6.8%
Materials 6.7%
Utilities 5.3%
Health Care 5.2%
Telecommunications 1.7%
Others 9.1%
</Table>
Fund holdings are subject to change and percentages shown above are based on
total net assets as of October 31, 2006. A complete list of holdings as of
October 31, 2006 is contained in the Schedule of Investments included in this
report. The most current available data regarding portfolio holdings can be
found on our website, www.chinafundinc.com. You may also obtain holdings by
calling 1-800-246-2255.
3
THE CHINA FUND, INC.
CHAIRMAN'S STATEMENT (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Dear Stockholders,
In July of this year, Alan Tremain resigned as Chairman of your Fund and I was
elected by the Board to replace him. Alan has been a Board member since 1992 and
was Chairman for 6 years. He saw the Fund through a number of testing markets
and was a primary architect of the highly successful rights offering in 2005. He
will remain as a member of the Board until March 2008, when his current term
expires. On behalf of the Board, I would like to thank Alan for his
contributions to the Fund over the years.
Your Fund enjoyed a good year in 2006. The Chinese economy remained buoyant,
attracting increasing interest from international investors. The breadth of the
stock market increased. Although the listing of China's large banks and other
state-owned enterprises gained the most media attention, your Fund looked to
benefit from the increasing number of fast-growing entrepreneurial companies
that are now coming to market. Also, last year's rights issue, which allowed the
Fund's Listed Investment Manager, Martin Currie, Inc. to reallocate a
substantial portion of the Fund's portfolio to A-shares, benefited the Fund.
Foreign investors still represent less than 2% of the market capitalization of
the domestic Chinese stock market, which indicates that your Fund is uniquely
positioned. Overall, the net asset value of your Fund increased by 49.6% during
the year, well ahead of the 32.3% increase in the benchmark index (MSCI Golden
Dragon).
Looking to the future, there are some important economic and political
developments which could benefit your Fund. The expectation is that the
government will increase spending on healthcare and education, opening these
sectors to increased private participation. Initiatives to stimulate the rural
economy could be accelerated. Growing wealth could increase domestic and
outbound tourism. In Taiwan, the expectation is that substantial changes in
policy towards mainland China will have a positive effect on the Taiwanese
market. These themes, already reflected in the portfolio, will be given added
emphasis over the coming year.
The Chinese economy's growth is being accompanied by a high rate of regulatory
and structural change. A number of these changes could favorably affect the
direct investment portfolio of the Fund. Issues related to the State
Administration of Foreign Exchange circular adversely impacted many deal
closings in 2005. These have now been resolved. New rules governing spin-offs
from State Owned Enterprises could facilitate deal flow, a new bankruptcy law
has been enacted and changes by the China Securities Regulatory Commission in
the rules regulating offshore and domestic listings were introduced. Importantly
the latter may aid exits from private companies through the A-share market. We
therefore anticipate a higher level of activity in the direct investment
portfolio during 2007.
Your Fund will, for the fourth year in succession, be paying a substantial cash
dividend. Shareholders have the possibility of reinvesting their dividends
through the Fund's Dividend Reinvestment and Cash Purchase Plan. For information
on the Plan and for monthly updates detailing your Fund's investments, please
visit the Fund's website (www.chinafundinc.com).
Thank you for your continued interest in The China Fund, Inc.
Sincerely,
James J. Lightburn
Chairman
4
THE CHINA FUND, INC.
INVESTMENT MANAGERS' STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
REVIEW OF LISTED INVESTMENTS
Over the past twelve months, the listed portfolio has outperformed the MSCI
Golden Dragon index by 18.94% in relative terms, enjoying net asset value growth
of 57%.
Martin Currie Inc.'s ("Martin Currie") investment approach hasn't changed.
Martin Currie invests in what it considers the best Chinese companies wherever
they are listed, with a bias towards smaller, management-owned companies and a
focus on growth and entrepreneurship. Martin Currie believe that such companies
will be the main beneficiaries of China's continuing economic growth.
Martin Currie has, however, substantially increased the Fund's weighting to
Taiwan in the six months since the Fund's last interim report. During this
period, investors have been nervous about the island, as President Chen
Shui-bian has been embroiled in political turmoil and corruption scandals.
Taiwan has thus lagged the rest of the Greater China region recently. But Martin
Currie expects the market to appreciate the value of Taiwanese companies in
early 2007, as the presidential election could bring matters into focus. All
candidates for the presidency -- not just the Kuomingtang party -- are likely to
advocate closer links with the mainland.
On the mainland, a staggering amount of money has been looking for a home in the
flotation of state-owned enterprises. Martin Currie generally does not invest in
poorly managed state-owned companies, but Martin Currie deviated somewhat from
these principles to invest in recent Initial Public Offerings ("IPOs"),
including the Hong Kong listing of CHINA MERCHANTS BANK.
Martin Currie did not, however, participate in the world's largest IPO, that of
INDUSTRIAL & COMMERCIAL BANK OF CHINA ("ICBC"). Martin Currie's reasoning was
that a bank of that size could not change the culture of state-ownership so
easily. Only last year, the Chinese government had to pay out US$15 billion to
cover non-performing loans at ICBC. With the bank running some 18,764 outlets
and a staff of 360,000, Martin Currie remains sceptical about ICBC'S ability to
meet expectations -- not that this has stopped other investors from investing.
At the stock level, the Fund saw strong performance from CHINA METAL PRODUCTS
and ZIJIN MINING GROUP, which rose by 270% and 268% respectively. CHINA
MERCHANTS BANK, CHAODA MODERN AGRICULTURE, TRIPOD TECHNOLOGY and GOLDEN MEDITECH
also outperformed. BIO-TREAT, BYD and CHINA FIRE SAFETY underperformed.
To increase the Fund's Taiwanese weighting, Martin Currie built new positions in
tech firms LITE-ON IT and WAH LEE, as well as in the conglomerate, LIEN HWA
INDUSTRIAL, and in FUBON, CHUNG HWA TELECOM and FAR EAST DEPARTMENT STORES. The
Fund also added a holding in solder specialist SHENMAO, and invested in food
giant UNI-PRESIDENT.
The Fund built an 11.6% stake in FAR EAST ENERGY, which is developing
high-potential coal-bed methane properties in China's Shanxi province, and looks
set to benefit from the government's efforts to develop alternative energy
sources. Earlier in the year, the Martin Currie increased the Fund's exposure to
the A-share market, adding to holdings in leading garment maker YOUNGOR, in
YANGTZE POWER and in ZHENHUA PORT MACHINERY, and adding a holding in the utility
HUANENG. Martin Currie's also invested in transformer
5
THE CHINA FUND, INC.
INVESTMENT MANAGERS' STATEMENTS (CONTINUED) (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
REVIEW OF LISTED INVESTMENTS (CONTINUED)
manufacturer BAODING TIANWEI BAOBIAN ELECTRIC, whose subsidiary is the first and
largest producer of photovoltaic cells in China.
Martin Currie cut some of the Fund's poor performing positions, including
TECHFAITH, CHINA TING, COMBA, LITE-ON IT and NOVATEK. Although markets were
unmoved by the arrest of Shanghai party boss Chen Liangyu, the Fund realized
gains in SHIMAO, the Shanghai-focused property developer. Martin Currie also
took advantage of strong interim results to realized gains in DIGITAL CHINA, and
to sell SOLOMON SYSTECH. In Hong Kong, the Fund realized gains in CHINA LIFE
INSURANCE.
Looking forward, Martin Currie expects valuations to be problematic. While
growth prospects are good and liquidity is strong, this seems to be largely
reflected in prices. Most good companies in the consumer sector, which has led
the market for a while, now trade on forward P/E ratios of around 30x. With the
exception of the inexpensive Taiwanese market, value resides only in deeply
unfashionable sectors (textiles, infrastructure, IPPs) or undiscovered small
caps.
6
THE CHINA FUND, INC.
INVESTMENT MANAGERS' STATEMENTS (CONTINUED) (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
REVIEW OF DIRECT INVESTMENTS
As of October 31, 2006 the Fund's Direct Investment portfolio comprised the
following investments:
CAPTIVE FINANCE LIMITED ("CAPTIVE")
Captive is engaged in providing operating and financial leases for technology
products (PCs, servers, telecom equipment etc.). It has operations in Greater
China, Singapore, Malaysia and Europe.
CDW HOLDING LIMITED ("CDW")
CDW manufactures a range of component parts for mobile telephones, office
equipment and household appliances manufactured by Japanese companies in China.
Its fastest growing business is the assembly of backlight unit components (BLU)
for the mobile phone industry. CDW continues to expand its production capacity
to meet the demands of its customers. The company is listed on the Singapore
Stock Exchange.
Shareholders of CDW approved the acquisition of the share capital of the
Japanese operations of its Chief Executive Officer. This will facilitate the
development of higher margin products and capture more manufacturing outsourcing
business from Japanese multinationals.
For the nine months ended September 30, 2006, the Company reported revenue of
US$113.8 mn (up 51.0% year over year ("yoy")) but net profit of US$4.3 mn (down
43.4% yoy). The profit decline mainly reflected continuous price pressure
particularly in its BLU business prior to the introduction of the next product
cycle.
TECO OPTRONICS CORP. ("TECO")
teco designs and manufactures organic light emitting diodes (OLED) displays. It
has a technology licensing agreement with Kodak. OLED is a new flat screen
display technology that is competing with liquid crystal displays (LCDs) and
though demand is growing rapidly excess manufacturing capacity in the industry
has eroded margins. teco is a subsidiary of the TECO Group, a large Taiwanese
business group.
On July 8, 2005, the carrying value of teco was reduced to US$150,000 from cost
of about US$590,000.
7
THE CHINA FUND, INC.
ABOUT THE PORTFOLIO MANAGERS (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
LISTED INVESTMENT MANAGER
Mr. Chris Ruffle serves as the portfolio manager for the Fund's portfolio of
listed securities. Mr. Ruffle joined Martin Currie in 1994. He is a Chinese and
Taiwanese equity specialist with over 16 years investment experience in Asia.
Fluent in Mandarin and Japanese, Mr. Ruffle has worked in the Far East since
1983. He worked originally in Beijing and Shanghai and then in Australia for a
metal trading company. He then moved to Warburg Securities in 1987 as an analyst
in Tokyo, before establishing Warburg's office in Taiwan. Mr. Ruffle also
manages The Martin Currie China Hedge Fund and the China "A" Share Fund.
DIRECT INVESTMENT MANAGER
Mr. KOH Kuek Chiang is the Executive Director of Asian Direct Capital Management
("ADCM") and is the portfolio manager of the Fund's portfolio of direct
securities. Mr. Koh joined ADCM in 1998. Mr. Koh has over ten years of private
equity investment experience in the United States, Europe and Asia working for
the Government of Singapore Investment Corporation, Union Bank of Switzerland
and private interests. His investment experience covers a wide range of
industries, including telecommunications equipment, biotechnology, media,
financial services and basic materials. Mr. Koh graduated with an engineering
degree from the University of Western Australia and has a post-graduate Diploma
in Business Administration from the National University of Singapore. He is a
Chartered Financial Analyst and is fluent in English and Mandarin.
8
THE CHINA FUND, INC.
SCHEDULE OF INVESTMENTS
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
NAME OF ISSUER AND TITLE OF ISSUE SHARES VALUE (NOTE A)
- --------------------------------- ------ --------------
COMMON STOCK AND OTHER EQUITY INTERESTS
HONG KONG
CONSUMER DISCRETIONARY -- (7.0%)
China Ting Group Holdings Ltd. ........................ 4,132,000 $ 956,174
China Travel International Investment Hong Kong,
Ltd. ................................................ 18,148,000 4,106,252
Huabao International Holdings Ltd.*.................... 12,790,000 5,705,637
Parkson Retail Group Ltd. ............................. 1,111,500 4,615,472
Ports Design Ltd. ..................................... 2,678,500 4,655,566
Shangri-La Asia Ltd. .................................. 4,318,000 9,370,424
Yorkey Optical International Cayman Ltd. .............. 7,128,000 2,483,368
------------
31,892,893
------------
CONSUMER STAPLES -- (5.5%)
Chaoda Modern Agriculture (Holdings) Ltd. ............. 34,089,900 20,641,953
Li Ning Co. Ltd. ...................................... 3,726,000 4,402,126
------------
25,044,079
------------
ENERGY -- (0.7%)
China Rare Earth Holdings, Ltd. ....................... 15,254,000 3,176,895
------------
FINANCIALS -- (1.5%)
China Insurance International Holdings Co., Ltd.*...... 6,974,000 6,007,045
China Merchants Bank Co., Ltd.*........................ 671,500 1,048,018
------------
7,055,063
------------
HEALTH CARE -- (4.2%)
China Shineway Pharmaceutical Group Ltd. .............. 7,615,000 4,699,106
Golden Meditech Co., Ltd.*............................. 35,040,000 10,811,339
Natural Beauty Bio-Technology, Ltd. ................... 32,780,000 3,666,337
------------
19,176,782
------------
INDEX FUND -- (1.5%)
iShares Asia Trust..................................... 780,000 6,929,100
------------
INDUSTRIALS -- (2.7%)
China Fire Safety Enterprise Group Holdings Ltd. ...... 50,380,000 3,950,865
TPV Technology, Ltd. .................................. 9,968,000 8,278,367
------------
12,229,232
------------
INFORMATION TECHNOLOGY -- (3.4%)
Arcontech Corp.(1)..................................... 18,386,000 236,369
Digital China Holdings Ltd. ........................... 10,000,000 4,178,183
Lenovo Group Ltd. ..................................... 25,646,000 10,913,192
------------
15,327,744
------------
</Table>
See notes to financial statements and notes to schedule of investments.
9
THE CHINA FUND, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
NAME OF ISSUER AND TITLE OF ISSUE SHARES VALUE (NOTE A)
- --------------------------------- ------ --------------
COMMON STOCK AND OTHER EQUITY INTERESTS (CONTINUED)
HONG KONG (CONTINUED)
MATERIALS -- (1.6%)
Asia Zirconium Ltd. ................................... 12,916,000 $ 1,228,751
Fountain Set (Holdings) Ltd. .......................... 13,026,000 3,784,632
Ocean Grand Chemicals Holdings Ltd.(1)................. 17,379,000 692,613
Sinochem Hong Kong Holdings Ltd. ...................... 5,000,000 1,767,693
------------
7,473,689
------------
UTILITIES -- (2.6%)
Xinao Gas Holdings, Ltd. .............................. 11,560,000 11,636,537
------------
TOTAL HONG KONG -- (Cost $84,989,709) 30.7% 139,942,014
------------
HONG KONG -- "H" SHARES
CONSUMER DISCRETIONARY -- (0.5%)
Lianhua Supermarket Holdings Co., Ltd. ................ 1,857,000 2,351,540
------------
ENERGY -- (2.9%)
China Oilfield Services Ltd. .......................... 12,650,000 7,106,833
China Shenhua Energy Co., Ltd. ........................ 3,435,000 6,032,281
------------
13,139,114
------------
INDUSTRIALS -- (3.4%)
Beiren Printing Machinery Holdings Ltd.+............... 7,000,000 1,457,865
BYD Co., Ltd.*......................................... 2,635,500 7,098,248
Zhejiang Expressway Co., Ltd. ......................... 10,304,000 6,967,801
------------
15,523,914
------------
MATERIALS -- (1.4%)
Zijin Mining Group Co., Ltd. .......................... 11,194,000 6,504,709
------------
UTILITIES -- (1.9%)
Anhui Expressway Co., Ltd. ............................ 12,406,000 8,437,069
------------
TOTAL HONG KONG -- "H" SHARES --
(Cost $28,078,314) 10.1% 45,956,346
----- ------------
TOTAL HONG KONG (INCLUDING "H" SHARES) --
(Cost $113,068,023) 40.8% 185,898,360
----- ------------
</Table>
See notes to financial statements and notes to schedule of investments.
10
THE CHINA FUND, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
NAME OF ISSUER AND TITLE OF ISSUE SHARES VALUE (NOTE A)
- --------------------------------- ------ --------------
COMMON STOCK AND OTHER EQUITY INTERESTS (CONTINUED)
SINGAPORE
UTILITIES -- (0.9%)
Bio-Treat Technology Ltd. ............................. 9,799,000 $ 3,837,934
------------
TOTAL SINGAPORE -- (Cost $4,045,565) 0.9% 3,837,934
----- ------------
TAIWAN
CONSUMER DISCRETIONARY -- (4.6%)
Far Eastern Department Stores Ltd. .................... 7,757,000 3,937,504
Merry Electronics Co., Ltd. ........................... 3,260,507 10,018,729
Synnex Technologies International, Corp. .............. 4,633,000 4,242,904
Taiwan FamilyMart Co., Ltd. ........................... 1,787,895 2,736,107
------------
20,935,244
------------
CONSUMER STAPLES -- (1.3%)
Uni-President Enterprises Corp. ....................... 6,729,000 6,000,253
------------
DISTRIBUTION/WHOLESALE -- (0.9%)
Wah Lee Industrial Corp. .............................. 2,154,000 4,289,182
------------
ENERGY -- (0.5%)
Formosa Petrochemical Corp. ........................... 1,211,000 2,374,939
------------
FINANCIALS -- (5.7%)
Cathay Financial Holding Co., Ltd. .................... 5,708,370 11,091,727
Fubon Financial Holdings Co., Ltd. .................... 10,387,000 8,479,822
Yuanta Core Pacific Securities Co. .................... 8,983,000 6,305,284
------------
25,876,833
------------
FOOD & BEVERAGES -- (0.5%)
Lien Hwa Industrial Corp. ............................. 4,768,616 2,226,647
------------
INDUSTRIALS -- (1.1%)
Cheng Shin Rubber Industry Co., Ltd. .................. 5,072,544 4,905,217
------------
INFORMATION TECHNOLOGY -- (6.6%)
Advanced Semiconductor Engineering Inc.*............... 7,838,000 7,260,687
Data Systems Consulting Co., Ltd. ..................... 4,566,813 3,521,928
Powertech Technology Inc. ............................. 1,522,000 4,387,872
ShenMao Technology Inc. ............................... 1,042,800 2,921,536
Taiwan Green Point Enterprises Co., Ltd. .............. 1,348,526 3,741,505
Tripod Technology Corp. ............................... 2,608,845 8,134,221
------------
29,967,749
------------
</Table>
See notes to financial statements and notes to schedule of investments.
11
THE CHINA FUND, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
NAME OF ISSUER AND TITLE OF ISSUE SHARES VALUE (NOTE A)
- --------------------------------- ------ --------------
COMMON STOCK AND OTHER EQUITY INTERESTS (CONTINUED)
TAIWAN (CONTINUED)
MATERIALS -- (2.6%)
China Metal Products Co., Ltd. ........................ 3,720,123 $ 7,609,470
Yieh United Steel Corp. ............................... 9,483,000 4,199,430
------------
11,808,900
------------
TELECOMMUNICATIONS -- (1.7%)
Chunghwa Telecom Co., Ltd. ............................ 4,490,880 7,711,407
------------
TOTAL TAIWAN -- (Cost $86,398,872) 25.5% 116,096,371
----- ------------
UNITED STATES -- "N" SHARES
CONSUMER DISCRETIONARY -- (1.2%)
Chindex International, Inc.*........................... 69,987 907,732
The9 Ltd. ADR*......................................... 184,861 4,364,568
------------
5,272,300
------------
ENERGY -- (2.7%)
Far East Energy Corp.+*................................ 11,111,111 12,444,444
------------
HEALTH CARE -- (1.0%)
Mindray Medical International Ltd. ADR*................ 259,900 4,704,190
------------
TOTAL UNITED STATES -- "N" SHARES --
(Cost $19,166,886) 4.9% 22,420,934
----- ------------
TOTAL COMMON STOCK AND OTHER EQUITY
INTERESTS -- (Cost $222,679,346) 72.1% 328,253,599
----- ------------
EQUITY LINKED SECURITIES
CONSUMER DISCRETIONARY -- (1.2%)
Youngor Group Co., Ltd. Access Product (expiration
10/26/10) 144A,(1)(2)................................ 7,562,730 5,603,983
------------
5,603,983
------------
</Table>
See notes to financial statements and notes to schedule of investments.
12
THE CHINA FUND, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
NAME OF ISSUER AND TITLE OF ISSUE SHARES VALUE (NOTE A)
- --------------------------------- ------ --------------
EQUITY LINKED SECURITIES (CONTINUED)
ENERGY -- (5.5%)
China Petroleum Access Product (expiration 01/20/10)
144A,*(1)(3)......................................... 7,089,920 $ 5,707,386
China Petroleum Access Product (expiration 01/20/11)
144A,(1)(2).......................................... 8,981,756 7,329,113
China Yangtze Power Co., Ltd. Access Product
(expiration 1/20/10) 144A,(1)(2)..................... 6,441,077 5,809,851
Huaneng Power International Inc. Access Product
(expiration 4/20/11) 144A,(1)(2)..................... 9,343,031 6,399,976
------------
25,246,326
------------
FINANCIALS -- (2.4%)
China Merchants Bank Co., Ltd. Access Product
(expiration 10/26/10) 144A,(1)(2).................... 8,254,855 10,904,664
------------
10,904,664
------------
INDUSTRIALS -- (9.3%)
Baoding Tianwei Baobian Electric Co., Ltd. Access
Product (expiration 01/20/10)144A*(1)(3)............. 1,761,193 3,784,364
Shanghai International Airport Co., Ltd. Access Product
(expiration 1/20/10) 144A*(1)(3)..................... 5,662,300 11,160,393
Shanghai International Airport Co., Ltd. Access Product
(expiration 10/26/10) 144A,(1)(2).................... 2,961,967 5,920,972
Shanghai Zhenhua Port Machinery Co., Ltd. Access
Product (expiration 10/26/10) 144A,(1)(2)............ 13,219,652 14,012,831
Xinjiang Tebian Electric Apparatus Stock Co., Ltd.
Access Product (expiration 10/26/10) 144A,(1)(2)..... 4,676,642 7,234,765
------------
42,113,325
------------
MATERIALS -- (1.0%)
Qinghai Salt Lake Potash Co., Ltd. Access Product
(expiration 10/26/10) 144A,(1)(2).................... 1,725,209 4,368,229
------------
RETAIL -- (0.4%)
Shanghai Yuyuan Tourist Mart Co., Ltd. Access Product
(expiration 01/20/10) 144A,*(1)(3)................... 1,550,470 1,892,522
------------
TOTAL EQUITY LINKED SECURITIES -- (Cost
$57,313,994) 19.8% 90,129,049
----- ------------
</Table>
See notes to financial statements and notes to schedule of investments.
13
THE CHINA FUND, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
NAME OF ISSUER AND TITLE OF ISSUE SHARES VALUE (NOTE A)
- --------------------------------- ------ --------------
DIRECT INVESTMENTS
FINANCIALS -- (0.7%)
Captive Finance, Ltd., (acquired 5/24/02)*+(1)(4)...... 2,000,000 $ 3,045,000
------------
INFORMATION TECHNOLOGY -- (1.6%)
CDW Holding Ltd., (acquired 1/26/05)+(5)............... 60,000,000 7,127,034
teco Optronics Corp., (acquired 4/26/04)*(1)(4)........ 1,861,710 150,000
------------
7,277,034
------------
TOTAL DIRECT INVESTMENTS -- (Cost $5,376,348) 2.3% 10,322,034
--- ------------
TOTAL INVESTMENTS -- (Cost $285,369,688) (Note D) 94.2% 428,704,682
---- ------------
OTHER ASSETS AND LIABILITIES 5.8% 26,501,396
--- ------------
NET ASSETS 100.0% $455,206,078
===== ============
</Table>
Notes to Schedule of Investments
- --------------------------------
* Denotes non-income producing security.
+ Affiliated issuer (see Note F).
(1) Security valued at fair value using methods determined in good faith by or
at the direction of the Board of Directors.
(2) Equity linked securities issued by Credit Lyonnais (CLSA).
(3) Equity linked securities issued by Citigroup Global Markets Holdings.
(4) Direct investments are generally restricted as to resale and do not have a
readily available resale market. On the date of acquisition of each direct
investment, there were no market quotations on similar securities, and such
investments were therefore initially valued at acquisition cost. These
direct investments are valued at fair value as determined by the Board of
Directors as discussed in Note A to the Financial Statements.
(5) This investment is listed on the Singapore Stock Exchange, however it is
still managed by Asian Direct Capital Management ("ADCM").
144A Securities restricted for resale to Qualified Institutional Buyers.
See notes to financial statements and notes to schedule of investments.
14
THE CHINA FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
ASSETS
Investments in listed investments, at value (cost
$267,502,486) (Note A)................................. $404,480,339
Investments in direct investments, at value (cost
$567,320) (Note A)..................................... 150,000
Investments in affiliated investments, at value (cost
$17,299,882) (Notes A and F)........................... 24,074,343
Cash...................................................... 14,631,951
Foreign currency, at value (cost $9,195,208).............. 9,185,832
Receivable for investments sold........................... 5,148,828
Receivable for fund shares sold........................... 632
Dividends receivable...................................... 130,502
Prepaid expenses and other assets......................... 48,979
------------
TOTAL ASSETS................................................ $457,851,406
------------
LIABILITIES
Payable for investments purchased......................... 2,027,339
Investment management fee payable (Note B)................ 239,852
Administration and custodian fees payable (Note B)........ 187,386
Directors fee payable (Note B)............................ 64,864
Accrued expenses and other liabilities.................... 125,887
------------
TOTAL LIABILITIES........................................... 2,645,328
------------
TOTAL NET ASSETS............................................ $455,206,078
============
COMPOSITION OF NET ASSETS:
Paid in capital (Note C).................................. $253,959,140
Undistributed net investment income....................... 4,319,290
Accumulated net realized gain on investments and foreign
currency transactions.................................. 53,601,581
Net unrealized appreciation on investments and foreign
currency translation................................... 143,326,067
------------
TOTAL NET ASSETS............................................ $455,206,078
============
NET ASSET VALUE PER SHARE
($455,206,078/14,496,220 shares of common stock
outstanding)........................................... $31.40
============
</Table>
See notes to financial statements.
15
THE CHINA FUND, INC.
STATEMENT OF OPERATIONS
YEAR ENDED OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividend income -- listed investments (including dividends
of $541,059 from non-controlled affiliates, net of tax
withheld of $487,292).................................. $ 9,443,533
Interest income -- listed investments..................... 26,196
------------
TOTAL INVESTMENT INCOME................................ 9,469,729
------------
EXPENSES
Investment Management fees (Note B)....................... 2,897,300
Custodian fees (Note B)................................... 767,036
Administration fees (Note B).............................. 464,158
Directors' fees and expenses (Note B)..................... 297,684
Legal fees................................................ 173,480
Printing and postage...................................... 160,704
Stock dividend tax expense................................ 105,527
Audit and tax service fees................................ 70,789
Insurance................................................. 55,076
Shareholder service fees.................................. 33,220
Stock exchange listing fee................................ 23,699
Transfer agent fees....................................... 19,690
Miscellaneous expenses.................................... 6,141
------------
TOTAL EXPENSES......................................... 5,074,504
------------
NET INVESTMENT INCOME....................................... 4,395,225
------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
AND FOREIGN CURRENCY
Net realized gain on listed investment transactions....... 55,811,933
Net realized loss on non-controlled affiliate
transaction............................................ (1,064,078)
Net realized loss on direct investment transactions....... (22,792)
Net realized loss on foreign currency transactions........ (20,151)
------------
54,704,912
------------
Net change in unrealized appreciation on listed
investments and foreign currency translation........... 95,378,102
Net change in unrealized depreciation on direct
investments............................................ (135,872)
------------
95,242,230
------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS AND FOREIGN
CURRENCY.................................................. 149,947,142
------------
NET INCREASE IN NET ASSETS FROM OPERATIONS.................. $154,342,367
============
</Table>
See notes to financial statements.
16
THE CHINA FUND, INC.
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
YEAR ENDED YEAR ENDED
OCTOBER 31, 2006 OCTOBER 31, 2005
---------------- ----------------
INCREASE IN NET ASSETS FROM OPERATIONS
Net investment income..................................... $ 4,395,225 $ 2,945,109
Net realized gain on investments and foreign currency
transactions........................................... 54,704,912 32,018,415
Net increase/(decrease) in unrealized
appreciation/(depreciation) on investments and foreign
currency translations.................................. 95,242,230 (41,317,713)
------------ ------------
Net increase (decrease) in net assets from operations..... 154,342,367 (6,354,189)
------------ ------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income..................................... (3,124,848) (1,979,079)
Capital gains............................................. (33,017,522) (34,014,358)
------------ ------------
Total dividends and distributions to shareholders......... (36,142,370) (35,993,437)
------------ ------------
CAPITAL SHARE TRANSACTIONS:
Fund shares sold (Note C)................................. -- 110,307,729
Reinvestment of dividends and distributions
(107,933 and 56,374 shares, respectively).............. 2,510,507 1,649,496
------------ ------------
Net increase in net assets from capital share
transactions........................................... 2,510,507 111,957,225
------------ ------------
NET INCREASE IN NET ASSETS.................................. 120,710,504 69,609,599
NET ASSETS:
Beginning of year......................................... 334,495,574 264,885,975
------------ ------------
End of year............................................... $455,206,078 $334,495,574
============ ============
Undistributed net investment income, end of period.......... $ 4,319,290 $ 3,069,063
============ ============
</Table>
See notes to financial statements.
17
THE CHINA FUND, INC.
FINANCIAL HIGHLIGHTS
SELECTED DATA FOR A SHARE OF COMMON STOCK OUTSTANDING FOR THE YEARS INDICATED
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
YEAR ENDED OCTOBER 31,
----------------------------------------------------
2006 2005 2004* 2003* 2002*
-------- -------- -------- -------- --------
PER SHARE OPERATION PERFORMANCE
Net asset value, beginning of year.............. $ 23.25 $ 26.27 $ 26.93 $ 14.92 $ 13.19
-------- -------- -------- -------- --------
Net investment income........................... 0.30 0.21 0.21 0.06 0.11
Net realized and unrealized gain on investments
and foreign currency transactions............. 10.36 0.34 0.91 12.16 1.75
-------- -------- -------- -------- --------
Total income from investment operations......... 10.66 0.55 1.12 12.22 1.86
-------- -------- -------- -------- --------
Less dividends and distributions:
Dividend from net investment income........... (0.22) (0.20) (0.07) (0.06) (0.13)
Distributions from net realized capital
gains....................................... (2.29) (3.37) (1.71) (0.15) 0.00
-------- -------- -------- -------- --------
Total dividends and distributions............... (2.51) (3.57) (1.78) (0.21) (0.13)
-------- -------- -------- -------- --------
Net asset value, end of year.................... $ 31.40 $ 23.25 $ 26.27 $ 26.93 $ 14.92
======== ======== ======== ======== ========
Per share market price, end of year............. $ 30.40 $ 24.55 $ 29.15 $ 34.74 $ 12.61
======== ======== ======== ======== ========
TOTAL INVESTMENT RETURN (BASED ON MARKET
PRICE)........................................ 37.20% (5.50)% (12.16)% 179.41% 18.63%
======== ======== ======== ======== ========
RATIOS AND SUPPLEMENTAL DATA
Net assets, end of year (000's)................. $455,206 $334,496 $264,886 $271,278 $150,319
Ratio of expenses to average net assets......... 1.26% 1.44% 1.41% 1.76% 1.97%
Ratio of expenses to average net assets,
excluding stock dividend tax expense.......... 1.23% 1.38% 1.34% 1.68% 1.85%
Ratio of net investment income to average net
assets........................................ 1.09% 1.04% 0.78% 0.32% 0.72%
Portfolio turnover rate......................... 50% 26% 40% 55% 68%
</Table>
* Financial highlights were audited by a previous audit firm.
See notes to financial statements.
18
THE CHINA FUND, INC.
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 2006
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The China Fund, Inc. (the "Fund") was incorporated under the laws of the State
of Maryland on April 28, 1992, and is a non-diversified, closed-end management
investment company registered under the Investment Company Act of 1940, as
amended. The Fund's investment objective is long-term capital appreciation
through investments in the equity securities of companies engaged in a
substantial amount of business in the People's Republic of China. The following
is a summary of significant accounting policies followed by the Fund in the
preparation of its financial statements.
USE OF ESTIMATES: The preparation of financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
income and expenses for the period. Actual results could differ from these
estimates. The significant estimates made as of, and for the year ended, October
31, 2006 relate to the valuation of the Fund's Direct Investments, as further
discussed below.
SECURITY VALUATION: Portfolio securities listed on recognized United States or
foreign securities exchanges are valued at the last quoted sales price in the
principal market where they are traded. Listed securities with no such sales
price and unlisted securities are valued at the mean between the current bid and
asked prices, if any, of two brokers. Short-term investments having maturities
of sixty days or less are valued at amortized cost (original purchase cost as
adjusted for amortization of premium or accretion of discount) which when
combined with accrued interest approximates market value. Securities for which
market quotations are readily available are valued at current market value.
Securities for which market quotations are not readily available are valued in
good faith at fair value using methods determined by the Board of Directors.
Direct Investments not traded on an exchange are valued at fair value as
determined by the Board of Directors based on advice from the Direct Investment
Manager.
REPURCHASE AGREEMENTS: In connection with transactions in repurchase
agreements, it is the Fund's policy that its custodian take possession of the
underlying collateral securities, the fair value of which exceeds the principal
amount of the repurchase transaction, including accrued interest, at all times.
If the seller defaults, and the fair value of the collateral declines,
realization of the collateral by the Fund may be delayed or limited.
FOREIGN CURRENCY TRANSLATIONS: The records of the Fund are maintained in U.S.
dollars. Foreign currencies, investments and other assets and liabilities are
translated into U.S. dollars at the current exchange rates. Purchases and sales
of investment securities and income and expenses, including stock dividend tax
expense, are translated on the respective dates of such transactions. Net
realized gains and losses on foreign currency transactions represent net gains
and losses from the disposition of foreign currencies, currency gains and losses
realized between the trade dates and settlement dates of security transactions,
and the difference between the amount of net investment income accrued and the
U.S. dollar amount actually received. The effects of changes in foreign currency
exchange rates on investments in securities are not segregated in the Statement
of Operations from the effects of changes in market prices of those securities,
but are included in realized and unrealized gain or loss on investments.
19
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
OPTION CONTRACTS: The Fund may purchase and write (sell) call options and put
options provided the transactions are for hedging purposes and the initial
margin and premiums do not exceed 5% of total assets. Option contracts are
valued daily and unrealized gains or losses are recorded based upon the last
sales price on the principal exchange on which the options are traded. The Fund
will realize a gain or loss upon the expiration or closing of the option
contract. When an option is exercised, the proceeds on sales of the underlying
security for a written call option, the purchase cost of the security for a
written put option, or the cost of the security for a purchased put or call
option is adjusted by the amount of premium received or paid.
The risk in writing a call option is that the Fund gives up the opportunity for
profit if the market price of the security increases and the option is
exercised. The risk in writing a put option is that the Fund may incur a loss if
the market price of the security decreases and the option is exercised. The risk
in buying an option is that the Fund pays a premium whether or not the option is
exercised. Risks may also arise from an illiquid secondary market or from the
inability of counter parties to meet the terms of the contract.
EQUITY LINKED SECURITIES: The Fund may invest in equity-linked securities such
as linked participation notes, equity swaps and zero-strike options and
securities warrants collectively, ("Access Products"). Equity-linked securities
are privately issued securities whose investment results are designed to
correspond generally to the performance of a specified stock index or "basket"
of stocks, or a single stock. These securities may be used by the Fund to gain
exposure to countries that place restrictions on investments by foreigners. To
the extent that the Fund invests in equity-linked securities whose return
corresponds to the performance of a foreign securities index or one or more
foreign stocks, investing in equity-linked securities will involve risks similar
to the risks of investing in foreign securities. In addition, the Fund bears the
risk that the issuer of an equity-linked security may default on its obligation
under the terms of the arrangement with the counterparty. Equity-linked
securities are often used for many of the same purposes as, and share many of
the same risks with, derivative instruments. In addition, equity-linked
securities may be considered illiquid and subject to the Fund's restrictions on
investments in illiquid securities.
At October 31, 2006, the Fund held equity-linked Access Product warrants through
Credit Lyonnais ("CLSA") and Citigroup Global Markets Holdings, the issuers.
Under the terms of the agreements, each warrant entitles the Fund to receive
from the issuers an amount in U.S. dollars linked to the performance of specific
equity shares.
INDEMNIFICATION OBLIGATIONS: Under the Fund's organizational documents, its
Officers and Directors are indemnified against certain liabilities arising out
of the performance of their duties to the Fund. In addition, in the normal
course of business the Fund enters into contracts that provide general
indemnifications to other parties. The Fund's maximum exposure under these
arrangements is unknown as this would involve future claims that may be made
against the Fund that have not yet occurred.
SECURITY TRANSACTIONS AND INVESTMENT INCOME: Security transactions are recorded
as of the trade date. Realized gains and losses from securities sold are
recorded on the identified cost basis. Dividend income is recorded on the
ex-dividend date, or, in the case of dividend income on foreign securities, on
the ex-dividend date or when the
20
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Fund becomes aware of its declaration. Interest income is recorded on the
accrual basis. All premiums and discounts are amortized/accreted for both
financial reporting and federal income tax purposes.
Dividend and interest income generated in Taiwan is subject to a 20% withholding
tax. Stock dividends received (except those which have resulted from
capitalization of capital surplus) are taxable at 20% of the par value of the
stock dividends received. The Fund records the taxes paid on stock dividends as
an operating expense.
DIVIDENDS AND DISTRIBUTIONS: The Fund intends to distribute to its
shareholders, at least annually, substantially all of its net investment income
and any net realized capital gains. Income and capital gains distributions are
determined in accordance with U.S. income tax regulations, which may differ from
generally accepted accounting principles. These differences are primarily due to
differing book and tax treatments for foreign currency transactions.
The Fund made distribution of $3,124,848 from Ordinary Income and $33,017,522
from Long-Term Capital Gains during the year ended October 31, 2006. For the
year ended October 31, 2005 the Fund made distributions of $3,061,875 from
Ordinary Income and $32,931,562 from Long-Term Capital Gains. As of October 31,
2006, the components of distributable earnings on a tax basis were $18,542,075
for undistributed ordinary income and $39,587,677 for undistributed long-term
capital gains. At that date, the Fund had $143,117,186 of net unrealized
appreciation on a tax basis. Income and capital gains distributions are
determined in accordance with U.S. income tax regulations, which may differ from
generally accepted accounting principles. These differences are primarily due to
differing book and tax treatments for foreign currency transactions.
FEDERAL INCOME TAXES: The Fund has qualified and intends to qualify in the
future as a regulated investment company by complying with the provisions of
Subchapter M of the Internal Revenue Code available to certain investment
companies, including making distributions of taxable income and capital gains
sufficient to relieve it from all, or substantially all, federal income and
excise taxes.
NOTE B -- ADVISORY FEE AND OTHER TRANSACTIONS WITH AFFILIATES
Martin Currie Inc. is the investment manager for the Fund's listed assets (the
"Listed Assets"). On August 3, 2005, the Fund completed a rights offering which
permitted the Fund's stockholders to purchase one new share for each three
shares of the Fund held. Prior to completion of the rights offering, Martin
Currie Inc. received a fee, computed weekly and payable monthly, at the
following rates: .70% of the first US$400 million of the Fund's average weekly
net assets in Listed Assets; and .50% of the Fund's average weekly net assets
invested in Listed Assets in excess of US$400 million. Effective as of the
completion of the rights offering, Martin Currie Inc. receives a fee, computed
weekly and payable monthly, at the following annual rates: 0.70% of the first
US$315 million of the Fund's average weekly net assets invested in Listed
Assets; and 0.50% of the Fund's average weekly net assets invested in Listed
Assets in excess of US$315 million.
Asian Direct Capital Management ("ADCM") is the investment manager for the
Fund's assets allocated to direct investments. ADCM receives a fee, computed
weekly and payable monthly at an annual rate equal to the
21
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
greater of $300,000 or 2.2% of the average weekly value of the net assets of the
Fund invested in Direct Investments.
No director, officer or employee of the Investment Manager or Direct Investment
Manager or any affiliates of those entities will receive any compensation from
the Fund for serving as an officer or director of the Fund. The Fund pays the
Chairman of the Board and each of the directors (who is not a director, officer
or employee of the Investment Manager or Direct Investment Manager or any
affiliate thereof) an annual fee of $27,500 and $12,000, respectively, plus
$2,000 for each Board of Directors' meeting or Audit Committee meeting attended.
In addition, the Fund will reimburse each of the directors for travel and
out-of-pocket expenses incurred in connection with attending Board of Directors'
meetings.
State Street Bank and Trust Company ("State Street") provides, or arranges for
the provision of certain administrative services for the Fund, including
preparing certain reports and other documents required by federal and/or state
laws and regulations. The Fund pays State Street a fee at an annual rate of .13%
of the Fund's average daily net assets up to $150 million, .11% of the next $150
million and .06% of those assets in excess of $300 million subject to certain
minimum requirements for fund administration services. The Fund also pays State
Street $100,000 per year for certain legal administration services, including
corporate secretarial services and preparing regulatory filings.
The Fund also has a contract with State Street to provide custody and fund
accounting services to the Fund. For these services, the Fund pays State Street
asset-based fees that vary according to the number of positions and transactions
plus out of pocket expenses.
NOTE C -- CAPITAL STOCK
The Board of Directors of the Fund has approved a share repurchase plan. Under
the program, the Fund will repurchase shares at management's discretion at times
when it considers the repurchase to be consistent with the objectives of the
program. For the year ended October 31, 2006, the Fund did not participate in
this program.
NOTE D -- INVESTMENT TRANSACTIONS
For the year ended October 31, 2006, the Fund's cost of purchases and proceeds
from sales of investment securities, other than short-term securities, were
$197,955,036 and $210,618,830, respectively. At October 31, 2006, the cost of
investments for federal income tax purposes was $285,578,569. Gross unrealized
appreciation of investments was $152,892,206, while gross unrealized
depreciation of investments was $9,766,093, resulting in net unrealized
appreciation of investments of $143,126,113.
NOTE E -- INVESTMENTS IN CHINA
The Fund's investments in China companies involve certain risks not typically
associated with investments in securities of U.S. companies or the U.S.
Government, including risks relating to (1) social, economic and political
uncertainty; (2) price volatility, lesser liquidity and smaller market
capitalization of securities markets in which securities of China companies
trade; (3) currency exchange fluctuations, currency blockage and higher
22
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
rates of inflation; (4) controls on foreign investment and limitations on
repatriation of invested capital and on the Fund's ability to exchange local
currencies for U.S. dollars; (5) governmental involvement in and control over
the economy; (6) risk of nationalization or expropriation of assets; (7) the
nature of the smaller, less seasoned and newly organized China companies,
particularly in China; and (8) the absence of uniform accounting, auditing and
financial reporting standards, practices and disclosure requirements and less
government supervision and regulation.
NOTE F -- INVESTMENTS IN NON-CONTROLLED AFFILIATES*:
<Table>
<Caption>
DIVIDENDS
INCLUDED IN
DIVIDEND
BALANCE OF BALANCE OF INCOME-
SHARES HELD GROSS GROSS SALES SHARES HELD VALUE NON-
OCTOBER 31, PURCHASES AND OCTOBER 31, OCTOBER 31, CONTROLLED
NAME OF ISSUER 2005 AND ADDITIONS REDUCTIONS 2006 2006 AFFILIATES
- -------------- ----------- ------------- ----------- ----------- ----------- -----------
Captive Finance,
Ltd. ............... 2,000,000 -- -- 2,000,000 $ 3,045,000 $ --
CDW Holdings Ltd...... 60,000,000 -- -- 60,000,000 7,127,034 480,000
Beiren Printing
Machinery Holdings
Ltd. ............... 7,000,000 -- -- 7,000,000 1,457,865 61,059
Nanjing Dahe Outdoor
Media Co., Ltd. .... 37,500,000 -- (37,500,000) -- -- --
Far East Energy
Corp. .............. -- 11,111,111 -- 11,111,111 12,444,444 --
----------- --------
$24,074,343 $541,059
=========== ========
</Table>
* Affiliated issuers, as defined in the Investment Company Act of 1940, as
amended, include issuers in which the Fund held 5% or more of the outstanding
voting securities.
NOTE G -- CAPITAL STOCK
On August 3, 2005, the Fund completed the rights offering of a total of 4
million shares of its common stock. Proceeds to the Fund, before expenses of
$1,339,771, amounted to $111,647,500. At October 31, 2006, 100,000,000 shares of
$.01 par value common stock were authorized.
NOTE H -- NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, Financial Accounting Standards Board Interpretation No. 48,
Accounting for Uncertainty in Income Taxes -- an interpretation of FASB
Statement 109 (FIN 48), was issued and is effective for fiscal years beginning
after December 15, 2006. FIN 48 sets forth a threshold for financial statement
recognition, measurement and disclosure of a tax position taken or expected to
be taken on a tax return. Management is
23
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
currently evaluating the impact, if any, the adoption of FIN 48 will have on the
Fund's net assets, results of operations and financial statement disclosures.
In addition, in September 2006, Statement of Financial Accounting Standards No.
157, Fair Value Measurements (SFAS 157), was issued and is effective for fiscal
years beginning after November 15, 2007. SFAS 157 defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. Management is currently evaluating the impact the
adoption of SFAS 157 will have on the Fund's financial statement disclosures.
NOTE I -- SUBSEQUENT EVENTS
Pursuant to an agreement between the Fund and Private Equity Management BVI
Limited ("PEML"), the Fund is entitled to certain additional consideration
related to the final disposition of a previously owned direct investment,
Shanghai Links Executive Community Limited ("SLEC"). ADCM was notified by the
prior direct investment manager, HSBC that it has received a final distribution
from PEML for the aforementioned additional consideration related to SLEC. The
Fund anticipates receiving additional consideration of US $239,349 on or before
December 31, 2006. The impact of the additional consideration on the Fund's Net
Asset Value per share is $0.017.
A recommendation was made by the listed investment advisor, Martin Currie, that
effective December 29, 2006 the valuation of 18,386,000 shares of Arcontech
Corporation, previously carried at an aggregate of US $236,369, be reduced to
zero. The impact of the proposed write-down, which is subject to ratification by
the Board's Valuation Committee, on the Fund's Net Asset Value per share is
$0.016.
24
REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
To the Board of Directors and Shareholders
of The China Fund, Inc.:
We have audited the accompanying statement of assets and liabilities, including
the portfolio of investments, of The China Fund, Inc. (the "Fund") as of October
31, 2006, and the related statement of operations for the year then ended, and
the statement of changes in net assets and the financial highlights for each of
the two years in the period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits. The financial highlights for each of the three years in the
period ended October 31, 2004 were audited by other auditors whose report, dated
December 10, 2004, expressed an unqualified opinion on the financial highlights.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2006, by correspondence with the custodian
and brokers; where replies were not received from brokers, we performed other
auditing procedures. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Fund as of October 31, 2006, the results of its operations for the year then
ended, and the changes in its net assets and the financial highlights for each
of the two years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
Boston, Massachusetts
December 29, 2006
25
THE CHINA FUND, INC.
OTHER INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TAX INFORMATION
CAPITAL GAINS DISTRIBUTIONS: $33,017,522 has been designated as capital
gains dividends for the purpose of the dividends paid deduction, of which 100%
represents 15% rate gains.
FOREIGN TAXES CREDIT: The Fund designates $592,819 as foreign taxes paid
and $9,930,824 as foreign source income earned for regular Federal income tax
purposes.
QUALIFIED DIVIDEND INCOME: For the fiscal year ended October 31, 2006, the
Fund will designate up to the maximum amount allowable pursuant to the Internal
Revenue Code, as qualified dividend income eligible for reduced tax rates. These
lower rates range from 5% to 15% depending on an individual's tax bracket.
Complete information will be reported in conjunction with Form 1099-DIV.
PRIVACY POLICY
- -------------------------------------------------------------------------------
PRIVACY NOTICE
The China Fund, Inc. collects nonpublic personal information about its
shareholders from the following sources:
[ ] Information it receives from shareholders on applications or other
forms; and
[ ] Information about shareholder transactions with the Fund.
THE FUND'S POLICY IS TO NOT DISCLOSE NONPUBLIC PERSONAL INFORMATION ABOUT ITS
SHAREHOLDERS TO NONAFFILIATED THIRD PARTIES (other than disclosures permitted by
law).
The Fund restricts access to nonpublic personal information about its
shareholders to those agents of the Fund who needs to know that information to
provide products or services to shareholders. The Fund maintains physical,
electronic and procedural safeguards that comply with federal standards to guard
its shareholders' nonpublic personal information.
- -------------------------------------------------------------------------------
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that are used by the Fund's
investment advisers to vote proxies relating to the Fund's portfolio securities
is available (1) without charge, upon request, by calling 1-888-CHN-CALL
(246-2255); and (2) as an exhibit to the Fund's annual report on Form N-CSR
which is available on the website of the Securities and Exchange Commission (the
"Commission") at http://www.sec.gov. Information regarding how the investment
advisers vote these proxies is now available by calling the same number and on
the
26
THE CHINA FUND, INC.
OTHER INFORMATION (CONTINUED) (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Commission's website. The Fund has filed its report on Form N-PX covering the
Fund's proxy voting record for the 12 month period ended June 30, 2006.
QUARTERLY PORTFOLIO OF INVESTMENTS
A Portfolio of Investments will be filed as of the end of the first and third
quarter of each fiscal year on Form N-Q and will be available on the Securities
and Exchange Commission's website at http://www.sec.gov. Form N-Q has been filed
as of July 31, 2006 for the third quarter of this fiscal year and is available
on the Securities and Exchange Commission's website at http://www.sec.gov.
Additionally, the Portfolio of Investments may be reviewed and copied at the
Commission's Public Reference Room in Washington, DC. Information on the
operation of the Public Reference Room may be obtained by calling
1-800-SEC-0330. The quarterly Portfolio of Investments will be made available
without charge, upon request, by calling 1-888-246-2255.
CERTIFICATIONS
The Fund's chief executive officer has certified to the New York Stock Exchange
that, as of October 31, 2006, he was not aware of any violation by the Fund of
applicable New York Stock Exchange corporate governance listing standards. The
Fund also has included the certifications of the Fund's chief executive officer
and chief financial officer required by Section 302 and Section 906 of the
Sarbanes-Oxley Act of 2002 in the Fund's Form N-CSR filed with the Securities
and Exchange Commission, for the period of this report.
27
BOARD DELIBERATIONS REGARDING APPROVAL OF
INVESTMENT MANAGEMENT AGREEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
GENERAL BACKGROUND
Martin Currie Inc. ("Martin Currie") acts as the Fund's investment manager, with
exclusive investment discretion over the Fund's assets, other than those
invested in direct investments (the "Listed Assets"), pursuant to a Management
Agreement with the Fund. The Fund pays Martin Currie a fee for its investment
management services, computed weekly and payable monthly, at an annual rate of
0.70% of the Fund's average weekly net assets consisting of Listed Assets up to
US$315 million and 0.50% of the Fund's average weekly net assets consisting of
Listed Assets in excess of US$315 million. Martin Currie is a registered
investment adviser under the U.S. Investment Advisers Act of 1940, as amended
(the "Advisers Act").
Asian Direct Capital Management ("ADCM") acts as investment manager to the Fund
with exclusive investment discretion over the portion of the Fund's assets that
is invested in direct investments pursuant to the terms of a Direct Investment
Management Agreement between the Fund and ADCM (the "Direct Management
Agreement"). The Fund may invest up to 25% of the net proceeds of its offerings
of its outstanding common stock in direct equity investments. For its direct
investment management services, ADCM receives from the Fund a fee, payable
monthly, at an annual rate of the greater of US$300,000 or 2.2% of the average
weekly assets of the Fund allocated to direct investments. ADCM is a registered
investment adviser under the Advisers Act. ADCM is a wholly owned, indirect
subsidiary of State Street Global Advisors ("SSgA"), the investment management
division of State Street Corporation. State Street Bank and Trust Company
("State Street"), an affiliate of State Street Corporation, serves as
administrator and custodian for the Fund.
The Fund's Board of Directors (the "Board") is legally required to review and
re-approve the Management Agreement and the Direct Management Agreement once a
year. Throughout the year, the Board considers a wide variety of materials and
information about the Fund, including, for example, the Fund's investment
performance, adherence to stated investment objectives and strategies, assets
under management, expenses, regulatory compliance and management. The Board
periodically meets with senior management and portfolio managers of both Martin
Currie and ADCM and reviews and evaluates their professional experience,
credentials and qualifications. This information supplements the materials the
Board received in preparation for the Meeting described below.
APPROVAL PROCESS
The Board, consisting entirely of "independent directors" within the meaning of
the Investment Company Act of 1940, unanimously approved the Management
Agreement and the Direct Management Agreement at an "in person" meeting held on
June 8, 2006 (the "Meeting"). In determining whether it was appropriate to
approve each of the Management Agreement and the Direct Management Agreement,
the Board requested information, provided by Martin Currie and ADCM, that it
believed to be reasonably necessary to reach its conclusion. At the Meeting, the
Board discussed issues pertaining to the proposed approval of the Management
Agreement and the Direct Management Agreement with representatives from Martin
Currie and ADCM and with legal counsel. This information together with the
information provided to the Directors throughout the course of year formed the
primary basis for the Directors' determinations.
28
BOARD DELIBERATIONS REGARDING APPROVAL OF
INVESTMENT MANAGEMENT AGREEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Prior to the Meeting, the Board met in an executive session for the purpose of
considering the approval of the Management Agreement and Direct Management
Agreement. During that executive session, the Directors reviewed a memorandum
which detailed the duties and responsibilities of the Directors with respect to
their consideration of the Management Agreement and Direct Management Agreement.
The Directors reviewed the contract renewal materials provided by Martin Currie
and ADCM, including, but not limited to (1) an organizational overview of each
of Martin Currie and ADCM and biographies of those personnel providing services
to the Fund, (2) a copy of each of the Management Agreement, Amendment No. 1 to
the Management Agreement and the Direct Management Agreement, (3) a
profitability analysis of each of Martin Currie and ADCM, (4) financial
statements of each of Martin Currie and ADCM, including, with respect to ADCM, a
letter of continuing financial support from SSgA, (5) Form ADV of each of Martin
Currie and ADCM, and (6) performance and fee comparison data provided by
Fundamental Data, a third party vendor of such information.
MANAGEMENT AGREEMENT
In evaluating the Management Agreement and its amendment, the Directors drew on
materials provided to them by Martin Currie. In deciding whether to renew the
Management Agreement and its amendment, the Directors considered various
factors, including (1) the nature, extent and quality of the services provided
by Martin Currie under the Management Agreement, (2) the investment performance
of the Fund's listed investments, (3) the costs to Martin Currie of its services
and the profits realized by Martin Currie, from its relationship with the Fund,
and (4) the extent to which economies of scale would be realized if and as the
Fund grows and whether the fee levels in the Management Agreement reflect these
economies of scale.
1. Nature, Extent and Quality of the Services provided by Martin Currie
In considering the nature, extent and quality of the services provided by Martin
Currie, the Directors relied on their prior experience as Directors of the Fund
as well as on the materials provided at the Meeting. They noted that under the
Management Agreement Martin Currie is responsible for managing the Fund's listed
investments in accordance with the Fund's investment objective and policies,
applicable legal and regulatory requirements, and the instructions of the
Directors, for providing necessary and appropriate reports and information to
the Directors, for maintaining all necessary books and records pertaining to the
Fund's transactions in listed investments, and for furnishing the Fund with the
assistance, cooperation, and information necessary for the Fund to meet various
legal requirements regarding registration and reporting. They noted the
distinctive nature of the Fund as investing primarily in equity securities of
China companies. They also noted the experience and expertise of Martin Currie
as appropriate as an adviser to the Fund.
The Directors reviewed the background and experience of Martin Currie's senior
management, including those individuals responsible for the investment and
compliance operations with respect to the Fund's listed investments, and the
responsibilities of the latter with respect to the Fund. They also considered
the resources, operational structures and practices of Martin Currie in managing
the Fund's listed portfolio, in monitoring and
29
BOARD DELIBERATIONS REGARDING APPROVAL OF
INVESTMENT MANAGEMENT AGREEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
securing the Fund's compliance with its investment objectives and policies and
with applicable laws and regulations, and in seeking best execution of portfolio
transactions. Drawing upon the materials provided and their general knowledge of
the business of Martin Currie, the Directors took into account the fact that
Martin Currie's experience, resources and strength in these areas are deep,
extensive and of high quality. On the basis of this review, the Directors
determined that the nature and extent of the services provided by Martin Currie
to the Fund were appropriate, had been of uniformly high quality, and could be
expected to remain so.
2. Investment Performance of the Fund's Listed Investments
The Directors noted that, in view of the distinctive investment objective of the
Fund, the investment performance of the Fund's listed investments was
satisfactory. Of importance to the Directors was the extent to which the Fund
achieved its objective. Drawing upon information provided at the Meeting and
upon reports provided to the Directors by Martin Currie throughout the preceding
year, the Directors determined that, while the Fund's listed investments had
underperformed the MSCI Golden Dragon Index during recent periods, the listed
investments had outperformed the Index for the three-year period ended April 30,
2006. The Directors discussed with the representatives of Martin Currie present
at the Meeting the reasons for the recent underperformance. They further
concluded, on the basis of the limited universe of comparable funds, that the
expense ratio of the Fund was as low as, or lower than, those of the Fund's
direct competitors. Accordingly, the Directors concluded that the performance of
the Fund was satisfactory.
3. The Costs to Martin Currie of its Services and the Profits realized by
Martin Currie from its Relationship with the Fund
The Directors considered the profitability of the advisory arrangement with the
Fund to Martin Currie. The Directors had been provided with data on the Fund's
profitability to Martin Currie for the Fund. They first discussed with
representatives of Martin Currie the methodologies used in computing the costs
that formed the bases of the profitability calculations. Concluding that these
methodologies were reasonable, they turned to the data provided. After extensive
discussion and analysis they concluded that, to the extent that Martin Currie's
relationship with the Fund had been profitable, the profitability was in no case
such as to render the advisory fee excessive.
In considering whether Martin Currie benefits in other ways from its
relationship with the Fund, the Directors noted that other than the advisory
fee, there is no other investment advisory and brokerage fee received or
receivable by Martin Currie from the Fund. The Directors concluded that, to the
extent that Martin Currie derives other benefits from its relationship with the
Fund, those benefits are not so significant as to render the adviser's fees
excessive.
30
BOARD DELIBERATIONS REGARDING APPROVAL OF
INVESTMENT MANAGEMENT AGREEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
4. The Extent to which Economies of Scale would be Realized if and as the Fund
Grows and whether the Fee Levels in the Management Agreement Reflect these
Economies of Scale
On the basis of their discussions with management and their analysis of
information provided at the Meeting, the Directors determined that the nature of
the Fund and its operations is such that Martin Currie was likely to realize
economies of scale in the management of the Fund as it grows in size. The Board
noted that, in contemplation of these likely economies of scale, this fee
structure with Martin Currie provides for breakpoints above which the fee rate
declines. It was noted in the Board's discussion with representatives of Martin
Curie that Martin Currie's assets under management from its China business had
increased substantially and as such Martin Currie had realized economies of
scale from managing more China portfolios for more clients. It was noted that
these economies of scale were shared with the Fund because they had enabled
Martin Currie to develop centralized dealing facilities that pool transactions
across all of its clients. However, Martin Currie had noted in its materials
provided to the Board that these economies of scale were not infinite and that
managing too much money may impair performance.
In order to better evaluate the Fund's advisory fee, the Directors had requested
comparative information with respect to fees paid by similar funds -- i.e.,
funds that invest in China. The Directors found that, because of the distinctive
nature of the Fund, the universe of similar funds was limited; the total number
of comparable funds, which included the Fund, was sixteen. Moreover, the Fund's
aggregate advisory fees were lower than many of its competitors'. The Directors
noted that the Fund's total expense ratio was lower than most of the comparable
funds' total expense ratio. The Directors concluded that the limited data
available provided some indirect confirmation of the reasonableness of Martin
Currie's fee.
APPROVAL OF MANAGEMENT AGREEMENT
The Directors approved the continuance of the Fund's Management Agreement and
its amendment after weighing the foregoing factors. They reasoned that,
considered in themselves, the nature and extent of the services provided by
Martin Currie were appropriate, that the performance of the Fund had been
satisfactory, and that Martin Currie could be expected to provide services of
high quality. As to Martin Currie's fees for the Fund, the Directors determined
that the fees, considered in relation to the services provided, were fair and
reasonable, that the Fund's relationship with Martin Currie was not so
profitable as to render the fees excessive, that any additional benefits to
Martin Currie were not of a magnitude materially to affect the Directors'
deliberations, and that the fees adequately reflected shared economies of scale
with the Fund.
DIRECT MANAGEMENT AGREEMENT
In deciding whether to renew the Direct Management Agreement, the Directors
considered various factors, including (1) the nature, extent and quality of the
services provided by ADCM under the Direct Management Agreement, (2) the
investment performance of the Fund's direct investments, (3) the costs to ADCM
of its services and the profits realized by ADCM, from its relationship with the
Fund, and (4) the extent to which
31
BOARD DELIBERATIONS REGARDING APPROVAL OF
INVESTMENT MANAGEMENT AGREEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
economies of scale would be realized if and as the Fund grows and whether the
fee levels in the Direct Management Agreement reflect these economies of scale.
1. Nature, Extent and Quality of the Services provided by ADCM
In considering the nature, extent and quality of the services provided by ADCM,
the Directors relied on their prior direct experience as Directors of the Fund
as well as on the materials provided at the Meeting. They noted that under the
Direct Management Agreement, ADCM is responsible for managing the direct
investments of the Fund in accordance with the Fund's investment objective and
policies, applicable legal and regulatory requirements, and the instructions of
the Directors, for providing necessary and appropriate reports and information
to the Directors, for maintaining all necessary books and records pertaining to
the Fund's direct investments, and for furnishing the Fund with the assistance,
cooperation, and information necessary for the Fund to meet various legal
requirements regarding registration and reporting. They noted the distinctive
nature of the Fund as investing primarily in equity securities of China
companies. They also noted the experience and expertise of ADCM in making direct
investments as appropriate as an adviser to such Fund.
The Directors reviewed the background and experience of ADCM's senior
management, including those individuals responsible for the investment and
compliance operations relating to the direct investments of the Fund, and the
responsibilities of the latter with respect to the Fund. They also considered
the resources, operational structures and practices of ADCM in managing the
Fund's direct investments, in monitoring and securing the Fund's compliance with
its investment objective and policies with respect to the Fund's direct
investments and with applicable laws and regulations. The Directors also
considered information about ADCM's overall investment management business,
noting that ADCM manages funds in South Korea and Thailand that invest in the
Asia Pacific region. In addition, ADCM, as a holding company of SSgA, has access
to the international business network of State Street Corporation for investment
opportunities. Drawing upon the materials provided and their general knowledge
of the business of ADCM, the Directors took into account the fact that ADCM's
experience, resources and strength in these areas are of high quality. On the
basis of this review, the Directors determined that the nature and extent of the
services provided by ADCM to the Fund were appropriate, had been of acceptable
quality, and could be expected to remain so.
2. Investment Performance of the Fund
The Directors noted that, in view of the distinctive investment objective of the
Fund, the investment performance of the Fund's direct investment portfolio was
satisfactory. Of importance to the Directors was the extent to which the Fund
achieved its objective. Drawing upon information provided at the meeting and
upon reports provided to the Directors by ADCM throughout the preceding year,
they determined that, while the Fund's direct investments had underperformed the
MSCI Golden Dragon Index during recent periods, the Fund's direct investment
portfolio's performance had been comparable to the performance of the MSCI
Golden Dragon Index for the three-year period ending April 30, 2006. They
further concluded, on the basis of the limited universe of comparable funds,
that the expense ratio of the Fund was as low as, or lower than, those of their
direct
32
BOARD DELIBERATIONS REGARDING APPROVAL OF
INVESTMENT MANAGEMENT AGREEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
competitors. Accordingly, they concluded that the performance of the Fund's
direct investment portfolio was satisfactory.
3. The Costs to ADCM of its Services and the Profits realized by ADCM from its
Relationship with the Fund
The Directors considered the profitability of the advisory arrangement with the
Fund to ADCM and of the Fund's relationship with ADCM's affiliate, State Street,
in its role as administrator and custodian for the Fund. The Directors had been
provided with data on the Fund's profitability to ADCM for the Fund's last four
fiscal years. They first discussed with representatives of ADCM the
methodologies used in computing the costs that formed the bases of the
profitability calculations. Concluding that these methodologies were reasonable,
they turned to the data provided. After discussion and analysis they concluded
that, to the extent that ADCM's relationship with the Fund had been profitable
to ADCM, the profitability was in no case such as to render the advisory fee
excessive. The Directors also noted SSgA's continuing support of ADCM as a
subsidiary.
In considering whether ADCM or its affiliates benefit in other ways from their
relationship with the Fund, the Directors noted that other than the advisory
fee, there is no other investment advisory and brokerage fee received or
receivable by ADCM or its affiliates; however, an affiliate of ADCM serves as
the Fund's administrator and custodian. The Directors noted that the fees paid
to the affiliate for administration and custody services were reasonable in
relation to the services provided. The Directors concluded that, to the extent
that ADCM or its affiliates derive other benefits from their relationship with
the Fund, those benefits are not so significant as to render the adviser's fees
excessive.
4. The Extent to which Economies of Scale would be Realized if and as the Fund
Grows and whether the Fee Levels in the Direct Management Agreement Reflect
these Economies of Scale
On the basis of their discussions with management and their analysis of
information provided at the Meeting, the Directors determined that the nature of
the Fund and its operations is such that ADCM would not at this time realize
economies of scale in the management of the Fund. It was noted that the
Directors had discussed ADCM's Pan Asia Investment Fund ("AAIF") which ADCM has
commenced marketing and which will also invest in Chinese securities. The
Directors noted that ADCM expected that AAIF's assets under management would
increase substantially and this may lead to the generation of some economies of
scale, only if AAIF and the Fund have a number of similar investments. Further,
these economies of scale would be greater than if there was no overlap between
the funds.
The Directors noted that there were no comparable funds investing in direct
investments for purposes of comparing the fees paid by the Fund to ADCM to the
fees paid by other funds. The Directors noted, however, that advisers to private
funds that principally make direct investments (typically referred to as
"private equity funds") typically pay their advisers an asset-based fee of 1% to
2% of the fund's assets plus a performance fee of 15% to 25% of the private
fund's gains on its investments. The Fund is not permitted under the Investment
Company Act of 1940 to pay a similar performance fee and the Directors concluded
that the fee paid to ADCM of the greater of $300,000 and 2.2% of the Fund's
daily net assets invested in direct investments was a reasonable
33
BOARD DELIBERATIONS REGARDING APPROVAL OF
INVESTMENT MANAGEMENT AGREEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
fee to obtain the services of a direct investment manager such as ADCM. The
Directors also noted that, notwithstanding this relatively high fee rate paid to
ADCM, the Fund's overall advisory fees, combining the fees paid to ADCM with
those paid to Martin Currie, were nevertheless competitive with the fees paid by
comparable funds investing solely in listed investments and that the Fund's
total expense ratio was lower than most of the comparable fund's total expense
ratios.
APPROVAL OF DIRECT MANAGEMENT AGREEMENT
The Directors approved the continuance of the Fund's Direct Management Agreement
after weighing the foregoing factors. They reasoned that, considered in
themselves, the nature and extent of the services provided by ADCM were
appropriate, that the performance of the Fund had been satisfactory, and that
ADCM could be expected to provide services of acceptable quality. As to ADCM's
fees for the Fund, the Directors determined that the fees, considered in
relation to the services provided, were fair and reasonable, that the Fund's
relationship with ADCM was not so profitable as to render the fees excessive,
that any additional benefits to ADCM were not of a magnitude materially to
affect the Directors' deliberations.
34
DIVIDENDS AND DISTRIBUTIONS;
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The Fund will distribute to shareholders, at least annually, substantially all
of its net investment income from dividends and interest earnings and expects to
distribute any net realized capital gains annually. Pursuant to the Dividend
Reinvestment and Cash Purchase Plan (the "Plan"), adopted by the Fund, each
shareholder will be deemed to have elected, unless Computershare Trust Company,
N.A., the Plan Administrator, is otherwise instructed by the stockholder in
writing, to have all distributions automatically reinvested by the Plan
Administrator in Fund shares pursuant to the Plan. Shareholders who do not
participate in the Plan will receive all distributions in cash paid by check in
U.S. dollars mailed directly to the stockholder by Computershare Trust Company,
N.A. (formerly, Equiserve Trust company, N.A.), as paying agent. Shareholders
who do not wish to have distributions automatically reinvested should notify the
Fund by contacting Computershare c/o The China Fund, Inc. at P.O. Box 43010,
Providence, Rhode Island 02940-3011. Phone: 1-800-426-5523.
Computershare Trust Company, N.A. and Computershare Shareholder Services, Inc.
(collectively, "Computershare" or the "Plan Administrator") acts as Plan
Administrator and Service Agent. If the Directors of the Fund declare an income
dividend or a capital gains distribution payable either in the Fund's Common
Stock or in cash, as shareholders may have elected, non-participants in the Plan
will receive cash and participants in the Plan will receive Common Stock, to be
issued by the Fund. If the market price per share on the valuation date equals
or exceeds net asset value per share on that date, the Fund will issue new
shares to participants at net asset value or, if the net asset value is less
than 95% of the market price on the valuation date, then at 95% of the market
price. The valuation date will be the dividend or distribution payment date or,
if that date is not a trading day on the exchange on which the Fund's shares are
then listed, the next preceding trading day. If net asset value exceeds the
market price of Fund shares at such time, participants in the Plan will be
deemed to have elected to receive shares of stock from the Fund, valued at
market price on the valuation date. If the Fund should declare a dividend or
capital gains distribution payable only in cash, the Plan Administrator will, as
administrator for the participants, buy Fund shares in the open market, on the
New York Stock Exchange or elsewhere, with the cash in respect of such dividend
or distribution, for the participant's account on, or shortly after, the payment
date.
Participants in the Plan have the option of making additional payments to the
Plan Administrator, annually, in any amount from $100 to $3,000 for investment
in the Fund's Common Stock. The Plan Administrator will use all funds received
from participants (as well as any dividends and capital gains distributions
received in cash) to purchase Fund shares in the open market on or about January
15 of each year. Any voluntary cash payments received more than thirty days
prior to such date will be returned by the Plan Administrator, and interest will
not be paid on any uninvested cash payments. To avoid unnecessary cash
accumulations, and also to allow ample time for receipt and processing by the
Plan Administrator, it is suggested that participants send in voluntary cash
payments to be received by the Plan Administrator approximately ten days before
January 15. A participant may withdraw a voluntary cash payment by written
notice, if the notice is received by the Plan Agent not less than 48 hours
before such payment is to be invested.
The Plan Administrator maintains all stockholder accounts in the Plan and
furnishes written confirmations of all transactions in the account, including
information needed by shareholders for personal and tax records. Shares in
35
DIVIDENDS AND DISTRIBUTIONS;
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN (CONTINUED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
the account of each Plan participant will be held by the Plan Administrator in
non-certificated form in the name of the participant, and each stockholder's
proxy will include those shares purchased pursuant to the Plan.
In the case of shareholders, such as banks, brokers or nominees, which hold
shares for others who are the beneficial owners, the Plan Administrator will
administer the Plan on the basis of the number of shares certified from time to
time by the stockholder as representing the total amount registered in the
stockholder's name and held for the account of beneficial owners who are
participating in the Plan.
There is no charge to participants for reinvesting dividends or capital gains
distributions. The Plan Administrator's fees for the handling of the
reinvestment of dividends and distributions will be paid by the Fund. However,
each participant's account will be charged a pro rata share of brokerage
commissions incurred with respect to the Plan Administrator's open market
purchases in connection with the reinvestment of dividends or capital gains
distributions. A participant will also pay brokerage commissions incurred in
purchases from voluntary cash payments made by the participant. Brokerage
charges for purchasing small amounts of stock for individual accounts through
the Plan are expected to be less than the usual brokerage charges for such
transactions, because the Plan Administrator will be purchasing stock for all
participants in blocks and prorating the lower commission thus attainable.
The automatic reinvestment of dividends and distributions will not relieve
participants of any income tax which may be payable on such dividends and
distributions.
Experience under the Plan may indicate that changes are desirable. Accordingly,
the Fund reserves the right to amend or terminate the Plan as applied to any
voluntary cash payment made and any dividend or distribution paid subsequent to
notice of the change sent to all shareholders at least 90 days before the record
date for such dividend or distribution. The Plan also may be amended or
terminated by the Plan Administrator by at least 90 days' written notice to all
shareholders. All correspondence concerning the Plan should be directed to
Computershare c/o The China Fund, Inc. at P.O. Box 43011, Providence, Rhode
Island 02940-3011. Phone: 1-800-426-5523.
36
DIRECTORS AND OFFICERS (UNAUDITED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The following table provides information concerning each of the Directors of the
Fund. The Board of Directors is comprised of Directors who are not interested
persons of the Fund, as that term is defined in Section 2(a)(19) of the
Investment Company Act of 1940, as amended. The Directors are divided into three
classes, designated as Class I, Class II and Class III. The Directors in each
such class are elected for a term of three years to succeed the Directors whose
term of office expires. Each Director shall hold office until the expiration of
his term and until his successor shall have been elected and qualified. The Fund
Complex consists of one series.
<Table>
<Caption>
PRINCIPAL OCCUPATION OR EMPLOYMENT
NAME (AGE) AND PRESENT OFFICE DURING PAST FIVE YEARS AND DIRECTOR
ADDRESS OF DIRECTOR WITH THE FUND DIRECTORSHIPS IN PUBLICLY HELD COMPANIES SINCE
- ------------------- --------------- ------------------------------------------------------ --------
James J. Lightburn (63)........ Chairman of the Chairman of the Board of the Fund; Attorney, Nomos 1992
13, Rue Alphonse de Neuville Board and (2004- present); Attorney, member of Hughes Hubbard &
75017 Paris, France Director Reed (1993-2004).
Alan Tremain (70).............. Director Chairman of the Board of the Fund; Chairman, Hotels of 1992
58 Avenue de la Reale Distinction Ventures, Inc. (1989-2005); Chairman,
Port la Galere Hotels of Distinction (International), Inc.
Theoule-sur-Mer (1974-present).
06590 France
Michael F. Holland (62)........ Director Chairman, Holland & Company L.L.C. (1995-present); 1992
375 Park Avenue Director, The Holland Balanced Fund, Inc., Reaves
New York, New York 10152 Utility Income Fund; Trustee, State Street Master
Funds and State Street Institutional Investment Trust
and Scottish Widows Investment Partnership Trust.
Joe O. Rogers (57)............. Director The Rogers Team LLC, organizing member (July 2001- 1992
2477 Foxwood Drive present); Manager, The J-Squared Team LLC (April 2003-
Chapel Hill, NC 27514 May 2004); Director, The Taiwan Fund, Inc.
(1986-present).
Nigel S. Tulloch (61).......... Director Chief Executive, HSBC Asset Management Bahamas Limited 1992
7, Circe Circle (1986-1992); Director, The HSBC China Fund Limited.
Dalkeith
WA6009
Australia
Gary L. French (55)............ President Senior Vice President, State Street Bank and Trust
2 Avenue de Lafayette Company (2002-present); Managing Director, Deutsche
Boston, MA 02111 Asset Management, Inc. and Zurich Scudder Investments
(acquired by Deutsche Bank in 2002) (2001-2002);
President, UAM Fund Services, Inc. (1995-2001).
William C. Cox (40)............ Treasurer Vice President, State Street Bank and Trust Company.
2 Avenue de Lafayette
Boston, MA 02111
Mary Moran Zeven (45).......... Secretary Senior Vice President and Senior Managing Counsel,
2 Avenue de Lafayette State Street Bank and Trust Company.
Boston, MA 02111
</Table>
37
(This page has been left blank intentionally.)
(This page has been left blank intentionally.)
(This page has been left blank intentionally.)
THE CHINA FUND, INC.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES ADDRESS
The China Fund, Inc.
c/o State Street Bank and Trust Company
P.O. Box 5049
Boston, MA 02206-5049
1-888-CHN-CALL (246-2255)
DIRECTORS AND OFFICERS
James J. Lightburn, Chairman of the Board and Director
Alan Tremain, O.B.E., Director
Michael F. Holland, Director
Joe O. Rogers, Director
Nigel S. Tulloch, Director
Gary L. French, President
William C. Cox, Treasurer
Mary Moran Zeven, Secretary
INVESTMENT MANAGER
Martin Currie Inc.
DIRECT INVESTMENT MANAGER
Asian Direct Capital Management
SHAREHOLDER SERVICING AGENT
The Altman Group
ADMINISTRATOR AND CUSTODIAN
State Street Bank and Trust Company
TRANSFER AGENT, DIVIDEND PAYING AGENT AND REGISTRAR
Computershare Trust Company, N.A.
INDEPENDENT AUDITORS
Deloitte & Touche, LLP
LEGAL COUNSEL
Clifford Chance US LLP
ITEM 2. CODE OF ETHICS.
(a) The China Fund, Inc. (the "Fund") has adopted a Code of Ethics that applies
to the Fund's principal executive officer and principal financial officer.
(c) There have been no amendments to the Fund's Code of Ethics during the
reporting period for this Form N-CSR.
(d) There have been no waivers granted by the Fund to individuals covered by
the Fund's Code of Ethics during the reporting period for this Form N-CSR.
(f) A copy of the Fund's Code of Ethics is attached as exhibit 12(a)(1) to this
Form N-CSR.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
(a) (1) The Board of Directors of the Fund has determined that the Fund has
one member serving on the Fund's Audit Committee that possesses the
attributes identified in Instruction 2(b) of Item 3 to Form N-CSR to
qualify as "audit committee financial expert."
(2) The name of the audit committee financial expert is Michael F.
Holland. Mr. Holland has been deemed to be "independent" as that term
is defined in Item 3(a)(2) of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) Audit Fees
For the fiscal year ended October 31, 2006, Deloitte & Touche LLP
("Deloitte"), the Fund's independent registered public accounting firm, billed
the Fund aggregate fees of US$53,000 for professional services rendered for the
audit of the Fund's annual financial statements and review of financial
statements included in the Fund's annual report to shareholders.
For the fiscal years ended October 31, 2005, Deloitte billed the Fund
aggregate fees of US$48,500 for professional services rendered for the audit of
the Fund's annual financial statements and review of financial statements
included in the Fund's annual report to shareholders.
(b) Audit-Related Fees
For the fiscal year ended October 31, 2006, Deloitte did not bill the Fund
any fees for assurances and related services that are reasonably related to the
performance of the audit or review of the Fund's financial statements and are
not reported under the section Audit Fees above.
For the fiscal year ended October 31, 2005, Deloitte did not bill the Fund
any fees for assurances and related services that are reasonably related to the
performance of the audit or review of the Fund's financial statements and are
not reported under the section Audit Fees above.
(c) Tax Fees
For the fiscal year ended October 31, 2006, Deloitte billed the Fund
aggregate fees of US$9,000 for professional services rendered for tax
compliance, tax advice, and tax planning. The nature of the services comprising
the Tax Fees was the review of the Fund's income tax returns and tax
distribution requirements.
For the fiscal year ended October 31, 2005, Deloitte billed the Fund
aggregate fees of US$8,500 for professional services rendered for tax
compliance, tax advice, and tax planning. The nature of the services comprising
the Tax Fees was the review of the Fund's income tax returns and tax
distribution requirements.
(d) All Other Fees
For the fiscal year ended October 31, 2006, Deloitte billed the Fund
US$15,000 for the provision of security counts.
For the fiscal year ended October 31, 2005, Deloitte billed the Fund
US$13,500 for the provision of security counts.
(e) The Fund's Audit Committee Charter requires that the Audit Committee
pre-approve all audit and non-audit services to be provided to the Fund by the
Fund's independent registered public accounting firm; provided, however, that
the pre-approval requirement with respect to non-auditing services to the Fund
may be waived consistent with the exceptions provided for in the Securities
Exchange Act of 1934, as amended (the "1934 Act"). All of the audit and tax
services described above for which Deloitte or KPMG billed the Fund fees for the
fiscal years ended October 31, 2006 and October 31, 2005, respectively, were
pre-approved by the Audit Committee.
For the fiscal years ended October 31, 2006 and October 31, 2005, the
Fund's Audit Committee did not waive the pre-approval requirement of any
non-audit services to be provided to the Fund by Deloitte or KPMG.
(f) Not applicable.
(g) For the fiscal year ended October 31, 2006, Deloitte did not bill the Fund
any non-audit fees. During the same period, the aggregate non-audit fees billed
by Deloitte for services rendered to State Street Bank and Trust Company, an
affiliate of the Fund's direct investment manager, Asian Direct Capital
Management, was approximately US$1,300,000. The non-audit services provided to
State Street Bank and Trust Company were not ongoing services and were not
related directly to the operations and financial reporting of the Fund. During
this period, Deloitte did not provide any services to Martin Currie Inc.
For the fiscal year ended October 31, 2005, Deloitte did not bill the Fund
any non-audit fees. During the same period, the aggregate non-audit fees billed
by Deloitte for services rendered to State Street Bank and Trust Company, an
affiliate of the Fund's direct investment manager, Asian Direct Capital
Management, was approximately US$700,000. The non-audit services provided to
State Street Bank and Trust Company were not ongoing services and were not
related directly to the operations and financial reporting of the Fund. During
this period, KPMG did not provide any services to Martin Currie Inc.
(h) The Fund's Audit Committee has determined that the provision of non-audit
services by Deloitte to State Street Bank and Trust Company is compatible with
maintaining Deloitte's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The Fund has a separately-designated audit committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the
Fund's audit committee are Alan Tremain, James J. Lightburn, Nigel Tulloch, Joe
O. Rogers and Michael F. Holland.
ITEM 6. SCHEDULE OF INVESTMENTS.
Schedule of Investments is included as part of Item 1.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
INVESTMENT COMPANIES.
Attached to this Form N-CSR as exhibit 12(a)(4) are copies of the proxy voting
policies and procedures of the Fund and its investment advisers, Asian Direct
Capital Management and Martin Currie, Inc.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(a)(1) As of December 31, 2006, the portfolio managers of the registrant are as
follows:
CHRIS RUFFLE
Mr. Ruffle is co-chairman of MC China Ltd. MC China Ltd is a subsidiary of
Martin Currie Investment Management, which provides investment research and
administration services to the Martin Currie. Mr. Ruffle, who is a Chinese and
Taiwanese equity specialist, has over 19 years investment experience in Asia.
Fluent in Mandarin, Mr. Ruffle has worked in Asia since 1983. He worked
originally in Beijing and Shanghai and then in Australia for a metal trading
company. He then moved to Warburg Securities in 1987 as an analyst in Tokyo,
before establishing Warburg's office in Taiwan (1990 to 1993). Mr. Ruffle also
manages The Martin Currie China Hedge Fund, the Martin Currie China ''A'' Share
Fund Limited and the China Development Capital Partnership.
KOH KUEK CHIANG
Mr. Koh joined the Direct Investment Manager in 1998. Mr. Koh has over twenty
years of private equity investment experience in the United States, Europe and
Asia working for the Government of Singapore Investment Corporation, Union Bank
of Switzerland and private interests. His investment experience covers a wide
range of industries, including telecommunication equipment, biotech, media,
financial services and basic materials. Mr. Koh graduated with an engineering
degree from the University of Western Australia and has a post-graduate Diploma
in Business Administration from the National University of Singapore. He is a
Chartered Financial Analyst and is fluent in English and Mandarin. Mr. Koh leads
a team of the Direct Investment Manager, comprised of Adrian Lam, Thomas Miu and
Kent Tsang, that works on the Fund's direct investment activities. The members
of the team are experienced private equity professionals with diverse
backgrounds and considerable experience in China. Most of the team members have
been involved in investing in China for over a decade and have seen more than
one economic cycle. On behalf of the Fund, Mr. Koh holds a directorship in the
following investee companies of the Fund's direct investment portfolio: Captive
Finance Limited. Mr. Koh does not receive directors' fees or compensation from
these companies. However, some direct expenses and costs of attending board
meetings are reimbursed in certain cases.
(a)(2)
As of October 31, 2006, Chris Ruffle managed 2 mutual funds with a total of
approximately $607 million in assets; 6 pooled investment vehicles other than
mutual funds with a total of approximately $678 million in assets; and 14 other
accounts with a total of approximately $945 million in assets.
Of these other mutual funds, no funds had performance based fees.
Of these other pooled investment vehicles, no pooled investment vehicles had
performance based fees.
Of these other accounts, no accounts had performance based fees.
As of October 31, 2006, Koh Kuek Chiang managed one other account with a total
of approximately US$32 million in assets. This account has a performance based
fee.
CONFLICTS OF INTEREST:
Mr. Ruffle's simultaneous management of the Fund and the other accounts noted
above may present actual or apparent conflicts of interest with respect to the
allocation and aggregation of securities orders placed on behalf of the Fund and
the other accounts. The Investment Manager, however, believes that sufficient
controls, policies and systems are in place which address such conflicts.
The Investment Manager has adopted several policies that address potential
conflicts of interest, including best execution and trade allocation policies
that are designed to ensure (1) that portfolio management is seeking the best
price for portfolio securities under the circumstances, (2) fair and equitable
allocation of investment opportunities among accounts over time and (3)
compliance with applicable regulatory requirements. All accounts are to be
treated in a non-preferential manner, such that allocations are not based upon
account performance, fee structure or preference of the portfolio manager. In
addition, the Investment Manager has adopted a Code of Conduct that sets forth
policies regarding conflicts of interest.
Mr. Koh's simultaneous management of the Fund and the other account noted above
may present actual or apparent conflicts of interest with respect to the
allocation of investment opportunities on behalf of the Fund and the other
account. The Direct Investment Manager, however, believes that these potential
conflicts of interest do not have an adverse effect on the portfolio management
of the Fund. The Direct Investment Manager has adopted several policies that
address potential conflicts of interest, including best execution and investment
opportunities allocation policies that are designed to ensure (1) that portfolio
management is seeking the best price for portfolio securities under the
circumstances, (2) fair and equitable allocation of investment opportunities
among accounts over time and (3) compliance with applicable regulatory
requirements. All accounts are to be treated in a non-preferential manner, such
that allocations are not based upon account performance, fee structure or
preference of the portfolio manager. In addition, the Direct Investment Manager
has adopted a Code of Conduct that sets forth policies regarding conflicts of
interest.
COMPENSATION:
Mr. Ruffle's compensation consists of a base salary together with an additional
element of remuneration dependent upon the performance of the accounts that he
manages.
Mr. Koh's compensation is comprised of two components: a base salary and an
annual bonus. His compensation is determined by a qualitative assessment of his
overall performance in managing the various funds for which he is responsible.
His bonus is determined by the Compensation Committee of the Direct Investment
Manager and is partially dependent on the performance of the funds in which Mr.
Koh is involved.
OWNERSHIP OF SECURITIES: The following table sets forth, for each portfolio
manager, the aggregate dollar range of the registrant's equity securities
beneficially owned as of October 31, 2006.
Portfolio Manager Dollar Range of Fund Shares Beneficially Owned
Chris Ruffle None
Koh Kuek Chiang None
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which shareholders may
recommend nominees to the registrant's Board of Directors during the period
covered by this Form N-CSR filing.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers have
concluded that the registrant's disclosure controls and procedures (as
defined in Rule 30a-3(c) under the Investment Company Act of 1940, as
amended (the "1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date
within 90 days of the filing date of this Form N-CSR based on their
evaluation of these controls and procedures required by Rule 30a-3(b) under
the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under
the 1934 Act (17 CFR 240.13a-15(b) or 240.15d-15(b)).
(b) There were no changes in the registrant's internal control over financial
reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR
270.30a-3(d))) that occurred during the registrant's second fiscal quarter
that has materially affected, or is reasonably likely to materially affect,
the registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of Ethics is attached hereto in response to Item 2(f).
(a)(2) The certifications required by Rule 30a-2 of the 1940 Act are attached
hereto.
(a)(3) Not applicable.
(a)(4) Proxy voting policies and procedures of the Fund and its investment
advisers are attached hereto in response to Item 7.
(b) The certifications required by Rule 30a-2(b) of the 1940 Act and Section
906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
THE CHINA FUND, INC.
By: /s/ Gary L. French
---------------------------------
Gary L. French
President of The China Fund, Inc.
Date: December 28, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By: /s/ Gary L. French
---------------------------------
Gary L. French
President of The China Fund, Inc.
Date: December 28, 2006
By: /s/ William C. Cox
---------------------------------
William C. Cox
Treasurer of The China Fund, Inc.
Date: December 28, 2006