Checking Out China Funds

Managers still see solid opportunities away from Shanghai's frenzy. Here are five savvy plays

by David Bogoslaw

Alan Greenspan may have warned of a possible "dramatic contraction" in Chinese equities in a May 23 speech, but investors appear so far to be unfazed. Despite the bubble talk, many fund pros are still focused on opportunities in the Middle Kingdom.

When investors think of opportunities to make money in China, companies riding the wave of huge exports are typically the first to spring to mind. But fund managers have begun to pay attention to stocks whose fortunes are tied more to growth in the domestic market, as the sizzling Chinese economy creates a widening population of eager consumers.

With China's economy growing at around 11% a year, investors are looking for ways to grab a piece of the action. Although the current Year of the Pig may excite investors with visions of becoming fat, happy, and prosperous, a note of caution is in order: Investors should be wary of gorging themselves amid what appears to be a stock-market bubble to many economists (see BusinessWeek.com, 5/18/07, "China Tries to Turn Down the Heat").

Consider the relatively new Shanghai Stock Exchange, whose composite index has jumped 50% since the beginning of the year. Some fund managers are steering clear of the index, warning that its sharp and sudden gains reflect a torrential inflow of domestic money with nowhere else to go at the moment. That's bound to change as the government's Qualified Domestic Institutional Investor (QDII) plan, which would allow a greater portion of domestic funds to be invested in other markets, gains traction, albeit ever so slowly. The government quota on how much money can be invested outside the country is a paltry $15 billion to $17 billion, chump change compared with China's $2.6 trillion economy.

With an eye toward prudence, some portfolio managers who wish to play China are sticking to stocks that list in Hong Kong, where transparency and corporate governance are far better than on the mainland. While economic growth is expected to moderate in 2007 due to slowing U.S. export demand, the continued rise in property prices is likely to support local investor sentiment in the months ahead, according to a May research note from Aberdeen Asset Management.

Obviously, investing in China carries notable risks. Investors who want some exposure to one of the world's most dynamic economies may want to do some homework first. With that in mind, this week's Five for the Money looks at a few funds with sizable exposure to China that remain open to new investors.

1. Guinness Atkinson China & Hong Kong Fund (ICHKX)

This $172 million fund has been making money by focusing on companies staking a claim in the infrastructure boom. That includes energy companies with ADRs trading on U.S. exchanges such as CNOOC (CEO), PetroChina (PTR), and Yangzhou Coal, and industrials such as Angang Steel and Dongfang Electrical Machinery.

Dongfang is one of the two largest domestic manufacturers of electrical turbines, which are in great demand in "a country installing the equivalent of the U.K. national grid every year," says Edmund Harriss, who has co-managed the fund since 1998.

He prefers Dongfang to its competitor Harbin Power, which he faults for over-diversifying, and points to Dongfang's slimmer balance sheet; cleaner, more straightforward business focus; and superior returns on investment.

In the auto industry, Harriss has been a buyer of Denway Motors, which, through a joint venture with Honda Motor (HMC), makes the Honda Accord and Odyssey for the Chinese market. There has been a general upgrade in the car models available to Chinese consumers; they're now as good as anything being sold in the U.S. or Europe, he says.