AMONG Asian equity funds, those invested in China and Greater China have posted runaway growth this year, raising the question of how sustainable the returns might be.
In the current year up to Nov 2, Lipper data show that China equity funds have returned an average of 68 per cent. The average return for Greater China funds - there are 14 registered for local sale - was 52 per cent.
Over a 12-month period, the average return for China equity funds was 101 per cent, and 74 per cent for Greater China funds.
Not surprisingly, broad averages mask the outperformance of the top ranking funds. DWS' China Equity fund, for example, returned 82 per cent this year and 118 per cent over a 12-month period. China equity unit trusts invest in China shares listed in Hong Kong. The Greater China universe is more diversified and covers China, Hong Kong and Taiwan. Some managers further broaden the mandates by investing in Chinese companies listed in Singapore. Some may also have a small exposure to domestic A shares. The good news is that fund managers contacted by Executive Money are sanguine about valuations for China H shares, even with a widely anticipated - or feared - correction in A shares. This implies that despite the recent drop, the rally could continue. The corollary to that, however, is that investors will have to hang on to their seats. China shares are vulnerable to broad swings, triggered by a variety of factors, foremost of which is regulatory pronouncements. For example, recent news putting a brake on a scheme to allow mainland Chinese to invest in Hong Kong equities has caused a sharp pullback. The proposal, announced earlier in August, had itself driven stocks to new highs. The Hang Seng China Enterprise Index, for example, fell 22 per cent. "H" shares are those listed in Hong Kong in which foreigners can invest. "A" shares are listed on the mainland and restricted to domestic investors. So far, much concern has centred on the massive appreciation in A shares, raising the spectre of a mania and subsequent correction. Over a 12-month period the Shanghai A share index has risen 176 per cent. From mid-November last year to its peak in October this year, the appreciation was an astounding 226 per cent. Says Richard Wong, Halbis investment director for equities: "I think this is a healthy correction. All the positive factors I see for China, such as strong economic growth, tax cut next year, robust consumption and good corporate earnings, still remain intact." H shares, he adds, have achieved an average earnings per share growth of 35 per cent. He expects a liquidity injection from the launch of more QDII (Qualified Domestic Institutional Investor) funds. QDII funds give Chinese investors an avenue to overseas investments. Mr Wong expects more QDII funds to be launched in the next 12 months - as many as 20 funds, each raising up to a staggering US$4 billion, and providing a strong liquidity support for China shares listed in Hong Kong.
"So far, five QDII funds have been launched raising US$18 billion from the PRC to invest in overseas stock markets. I believe the Chinese companies listed in HK and elsewhere will benefit from the inflow from China as these new funds would likely invest in familiar names they know... With good corporate earnings growth and ample market liquidity, I think China shares have good upside, especially after the recent corrections," says Mr Wong.
Mark Tan Keng Yew, director of UOB Asset Management, says the United Greater China Fund has not been affected as much by the sharp volatility due to its diversified nature. "I don't think there is a bubble. The A share market looks pretty high and there could be some degree of excess valuation. But the stocks in Hong Kong and Singapore are decently valued. We're seeing quite a lot of good stocks, good valuations and fundamentals in the mid-cap space."
Louisa Lo of Schroders wrote in a note earlier this month that the sharp correction was an "excellent buying opportunity to add to Asian positions".
"We believe investors are using the delay in the scheme (to allow mainland Chinese to invest directly in Hong Kong) as an excuse to take profits. We expect this to have only a short-term impact on the market given that the region's strong fundamentals remain intact.
"However, we may see a shift to more fundamental investing, in line with our more cautious positioning, and out of momentum plays that have benefited many of the overvalued China names where we remain underweight." BCA Research warned in a Nov 9 note, however, that the risk of overweighting H shares has increased, as a lot of the good news has been priced in. It points out that the massive gains in emerging markets this year are partly thanks to China.
"Markets are starting to discount continuously positive news out of China.
"If global equity markets stabilise, Chinese H shares will re-test and surpass their recent highs. However, the risk/reward profile of Chinese H shares is deteriorating and investors should consider reducing exposure to this market on strength."
Meanwhile, an October paper by Morgan Stanley Research tackles the question of the potential impact of the bursting of the stock market bubble for China. Written at a time when the Shanghai A share index hovered at 6,000 - it has now fallen to about 5,400 - analyst Qing Wang said the negative impact of a potential correction has become substantially larger.
"We estimate the negative wealth effect could cause personal consumption and GDP to decline by 1.2 and 4 per cent, respectively, if the market were to drop by 30 per cent from current levels - and by 2.4 and 0.8 per cent, respectively, if the market were to drop by 60 per cent to the level of late May."
In the second scenario of a 60 per cent drop, there could be a contagion effect on the property market, causing property prices to fall by 10 per cent on average.
