Be aware of emerging market risks

Burgeoning stocks in China may appear flameproof, but ill-prepared investors could easily get burnt if they disregard the inherent dangers.

BYD, whose investors include Warren Buffet, have recently moved beyond mobile phones and begun manufacturing cars. Kevin Lee / Bloomberg

With the value of some stocks now rising by up to 500 per cent a year and China poised to spend almost US$4 trillion (Dh14.6tn) on improving its infrastructure, it looks the perfect time to invest in the dragon economy.

But China is filled with pitfalls for the unwary investor.

"Now is a good time to invest in China. Stocks in big companies such as China Mobile, the national telecommunications operator, are still relatively cheap," says Charlie Awdry, the head of Chinese equities at Gartmore, a London-based fund manager.

According to Gartmore, key investment sectors include retail, which is seeing sales growth of 18 per cent a year, and cement production, in which China is now supplying the Middle East.

"China is also making cement plants for the Middle Eastern market and has taken market share from traditional players like the Germans," says Mr Awdry.

He also says Chinese car manufacturers are catching up with their western counterparts, including Cherry and Geely, which is buying Volvo."BYD, whose investors include Warren Buffet, was making mobile phones when I first visited them in 2003. They had just started making cars, but they looked like cardboard boxes back then," says Mr Awdry. "Now they look like Hyundai models and are being used as public taxis in Santiago. If you are competing against these guys, you better watch out."

He adds that China is now becoming a major outsourcing centre for western companies.

"WuXi PharmaTech is a well-positioned pharmaceuticals outsourcing operation doing research and development for western drugs companies," says Mr Awdry.

Research company Ovum also believes that China is building a substantial IT infrastructure as well as starting to rival India as an outsourcing destination for IT companies.

"The current Chinese urbanisation drive, in which over one billion people are expected to live in the cities by 2030, is a clear part of the reasoning behind this huge infrastructure investment. These trends have also gone hand-in-hand with substantial IT service provider investments," says Jens Butler, an analyst at Ovum.

According to Ovum, some Chinese IT outsourcing companies have become stellar high-growth stocks.

"VanceInfo Tech, is listed on the [New York Stock Exchange] and has risen sevenfold in the last 18 months, and now has a market valuation of $1.3 billion," says Patrick O'Brien, another analyst at Ovum.

But he adds that VanceInfo, a Chinese outsourcing company, is rare in that it is listed on a foreign stock exchange. To invest in most high-growth Chinese stocks, it is necessary to buy through an exchange closer to the mainland. Fortunately, many Chinese stocks are now traded in Hong Kong.

When Britain returned the banking and financial hub of Hong Kong to China in 1997, China was provided with instant access to the international capital markets and has seen external investment increase ever since.

"Traditionally, fund managers have bought and sold Chinese stocks in Hong Kong," says Mr Awdry. "My fund buys 85 per cent of its Chinese stocks in Hong Kong. Some Chinese stocks such as Chinese search engine Baidu are also traded in the United States."

But Mr Awdry says there are many companies that are listed only on the Shanghai stock exchange. "In order to buy stocks on the Shanghai exchange, you must be an accredited Qualified Foreign Institutional investor or you must have one act for you. About 6 per cent of my fund's stock was acquired on the Shanghai exchange," says Mr Awdry, who heads Gartmore's China Opportunities Fund.

For investors who wish to spread their risk and don't want to monitor the performance of specific equities, another route to investing in China is via a fund managed by a foreign financial institution.

"While investing directly in a company gives potentially high returns, it is a high-maintenance strategy for the investor, who must continually monitor the specific company and buying into a portfolio of shares also spreads risk," says Mr Awdry.

But investors who are tempted to jump on China's equities bandwagon had also better be prepared for what could be a rocky rise in the medium term.

"Anyone who invests in emerging markets equities should take a long-term view. It is a risky and volatile asset class," says Mr Awdry. "There are a number of key indicators underpinning the long-term investment view in China. One is the Chinese consumer who has been transformed by economic change and social change.

"The social angle is even more important. Communism in China is 61 years old and a 60-year-old man will have cautious spending habits. By contrast, his 20-year-old granddaughter, a product of China's one-child-per-family law, will be healthy, well educated and on the internet. In short, she will be a consumer."

He also believes that the trillions being spent on China's infrastructure will fuel economic growth.

"The Chinese communist party sees investment as a way of stimulating growth during an economic downturn. One example is China's new high-speed train network. These will not make a profit for years, but [will] stimulate growth and create jobs," says Mr Awdry.

According to Ovum: "Through China's massive investment in infrastructure, it now has over 40,000km of highway-quality roads and more high-speed railway kilometres than the whole of Europe and by the end of 2011 more than the rest of the world, the highest number of internet users in the world and reliable utilities supplies to most of the major tier-one cities."

And, after a decade of fears that China might revert to a simpler form of communist control and simply seize foreign investments, investors are increasingly comforted by Beijing's reassurances that their assets are in safe hands.

"Although China is a one-party state, it is extremely unlikely that China would ever seize investors' assets. In fact, they have taken steps to enshrine property rights," says Mr Awdry.