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Bulls In The China Shop



When Beijing first allowed foreigners to buy shares on China's two fledgling stock markets in February, investor enthusiasm was at a fever pitch. China has long been considered to have enormous potential as a manufacturing center and consumer market. But U.S. investors had no easy way to take a direct stake in China's economic future.

Not surprisingly, professional investment managers have come to the rescue with mutual funds to invest in Chinese securities. The first closed-end China fund available to U.S. investors, China Fund Inc., was launched on July 10, and two similar funds, Greater China Fund Inc. and Jardine Fleming China Region Fund Inc., came to market soon after. So far, the funds have attracted a hefty $300 million. But just as the funds are making their debut on the New York Stock Exchange, the romance with China is cooling off. While the potential seems seductive, the risk to fund investors is high.

`CONFLICTS.' One reason is political uncertainty. "Unfortunately, by the time the funds came out, we had the beginnings of conflict over human-rights issues with China, and now additional conflict over trade," says Frank Cappiello, publisher of Capiello's Closed-End Fund Digest in Santa Barbara, Calif.

But the main problem has been concern about the high valuation of Chinese stocks, even though prices have been coming down recently. "We have passed the first few months of euphoria," says Dudley Howard, director of investor relations for the $101 million Jardine Fleming China Region Fund Inc. "Considerable caution is being used at this moment."

The universe of Chinese securities is still very limited. Only 17 stocks listed on China's Shanghai and Shenzhen exchanges offer the "B" shares that foreigners can invest in. While more issues are needed to broaden the market, analysts caution that many listings may turn out to be premature. "When a government starts to push companies into the marketplace that aren't ready, estimates on which they're brought to market turn out not to hold too much water," says William McBride, international editor for Lipper Analytical Services Inc.

The reliability of financial data is a constant worry. Accounting practices and securities regulation in China are primitive at best. Recently, the market was jolted when the first issue to list "B" shares on the Shanghai Exchange, Shanghai Vacuum Electron Device Co., issued a $110 million rights offering after its original $73 million offering. "No one's sure what they did with the first $73 million," says Matthew Sarno, a securities analyst with Asia SecuritiesInc., one of the top five brokerages in Taiwan.

Managers of the new China funds, as a result, are very wary. All three have most of their assets still in cash and plan to make less direct--but more secure--China-related investments via the Hong Kong stock exchange and other Asian exchanges. China Fund Inc., for example, plans to invest 65% of its assets in companies that trade mainly with China, get at least 50% of revenues from China, or have 50% of their assets in the country. The fund estimates that 50 companies on the Hong Kong exchange fit the bill.

Such strategies make the funds similar to the numerous Pacific Basin mutual funds, many of which are also investing heavily in the Hong Kong market. "We prefer to buy China on the cheap by using Hong Kong securities, which have attractive valuations, good dividend yields, and dollar-linked currencies," says Andrew Economos, the portfolio manager for the $115 million Scudder New Asia Fund.

GROUND FLOOR. Economos' China plays include China Power & Light Co. About 20% of the company's sales are to China's special economic zones, where there's a shortage of electric power. Unlike the electricity it sells in Hong Kong, which is subject to rate regulations, the 20% sold to China goes for whatever the market will bear.

Even if the economics of Chinese investments improve, the political risks remain substantial. The key question is whether reformers will keep an upper hand in the ongoing and hard-fought battle against hard-liners. There's also plenty of uncertainty about what happens in 1997, when Hong Kong reverts to Chinese rule.

If anything is clear, it's that investors need to take a long-term view. "There are going to be nasty shocks along the way," says McBride. "What fund managers are counting on is that the sheer vigor of the economic situation will be such that these things are surmountable."THREE WAYS TO PLAY CHINA

CHINA FUND The $110 million fund plans to invest at least 65% in companies that

trade mainly with China. It will also consider companies that derive at least

50% of their revenues from, or have at least 50% of their assets in, China

GREATER CHINA FUND The $95 million fund will invest "substantially all" of

its assets in companies that get at least 50% of revenues from China. At least

65% will be in stocks listed on the Chinese and Hong Kong exchanges, but the

fund may also invest in stocks listed on exchanges in Korea, Singapore, and


JARDINE FLEMING CHINA REGION FUND Jardine's $101 million fund plans to invest

its assets in equities listed on China, Hong Kong, Taiwan, and Macao exchanges.

Like the other two funds, it may make modest late-stage venture-capital



Suzanne Woolley in New York and Joyce Barnathan in Hong Kong

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