Investors told to keep the faith in China

Despite a recent slide, the country's case is 'compelling', finds Simon Hildrey

China has been popular with many fund managers and advisers for the past two years. But investors are growing increasingly concerned that things may be turning sour.

A fall of more than 20 per cent in the Chinese stock market since April has been compounded by warnings from the IMF of a possible hard landing for the economy.

Since May, the Chinese government has been trying to prevent the economy from overheating. But in a move that is likely to concern investors, it last week revealed it was suspending initial public offerings for "A" shares until October.

But rather than seeing this as proof that China's economic miracle is unravelling, some fund managers believe it may present a buying opportunity. They remain confident about the country's long-term prospects, although they admit growth might slow in the short term.

Steven Dunaway, the IMF's mission chief for China, believes economic growth is likely to slow to between 7.5 and 8 per cent in the second half of this year, and to 7.5 per cent in 2005, compared to 9.1 per cent in 2003.

But Yang Liu, manager of the Atlantis China fund, remains upbeat. "Most companies have reported better-than-expected earnings in 2003 and the first six months of this year," she says. "There has been no change to the fundamentals in China, so we expect economic growth to remain at 9 per cent.

"This is further supported by the fact that the private sector comprises over 50 per cent of gross domestic product growth. GDP reached only $1,000 per head of the population last year, so there is scope for more growth before it overheats."

She adds that attempts by the government to prevent overheating - through such measures as limiting state investment - have been focused on smaller firms and peripheral developments such as golf courses. "The large enterprises will get stronger by acquiring the smaller ones. The government is investing in key sectors like energy, transportation and electronics."

Ms Liu puts the 20 per cent fall in the Chinese stock market down to a chain reaction. "Some investors became worried about the economy overheating so they withdrew from the market. This led to panic among other investors and further falls in the market.

"When investors see that there is no overheating and no hard landing for the economy, they will start reinvesting. Valuations are back down to the same levels as they were when we had the Sars outbreak in March 2003. Companies are on single-digit price-to-earnings ratios, with earnings rising, so they offer investors value."

Martin Lau, director of Greater China equities at First State Investments, says the suspension of "A" shares is not a concern as foreign investors tend to buy "B" shares listed in China and "H" shares listed in Hong Kong. He is optimistic about the outlook for the market. "Investment growth at 40 per cent was not sustainable but we still believe economic growth will be 7 or 8 per cent over the next two years. While investment will slow, consumption will rise. One reason for this is that China has one of the highest savings rates in the world at more than 40 per cent.

"We are also optimistic because although inflation is rising, it is below 5 per cent and there is no sign of the economy overheating."

Hugh Young, manager of the Far East Emerging Economies fund at investment house Aberdeen, believes a slowdown in the Chinese economy isn't all doom and gloom as it will lead to "sustainable growth", though having a detrimental effect on earnings in the short term.

But Mr Young is cautious about stocks listed in China. "We cannot find any companies in the country we like, at prices we feel offer value. We do not believe the quality of management is very good and there are a lot of dull companies."

Gary Potter, co-manager of the Credit Suisse Portfolio Service, thinks investors should look beyond the short-term volatility. "In terms of macro economics," he says, "there is an almost unstoppable force behind China and Asia in general. The economy may slow but China cannot afford to suffer a hard landing because of the number of people moving from rural areas to cities. The country needs to create one million jobs a month to cope with the movement of migrants.

"The 10-year story for wealth creation and the growth in demand in China is compelling," he adds. "This has positive implications for the whole region. Most fund managers gain exposure to China through companies listed in Hong Kong, Taiwan and Singapore. But if China suffers a downturn, investors gain protection by investing through these three countries."

Among the funds Mr Potter recommends are Aberdeen Far East Emerging Economies, Solus Eastern Enterprise (managed by Chris Wong), and Invesco Perpetual Pacific (managed by Stuart Parks).