Chinese way to invest can prove rollercoaster ride

Last year Shanghai stock prices jumped 90 per cent and the country reported an eight per cent annual growth. It is expected to stay around that level for the next five years with an occasional 12 per cent likely to be recorded.

This year China will pass Japan to become the world's second largest economy after the US. Much of this achievement has been export-led. With short-term inflation under control, the Chinese are experiencing growth in real terms.

Neither their banks nor their consumers have the balance sheet or liquidity problems of the West. There is an enormous current account surplus and a massive savings ratio, leaving great opportunities for consumerism and commensurate growth.

Yet this has been achieved through a giant government stimulus package, rumoured to be $586bn (367bn), much of it designed to build more infrastructure.

A giant wave of bank lending accompanied this package. In the first 10 months of 2009, around $1.3 trillion was lent by Chinese banks, which is an almost 100 per cent rise on the year before. On the cautionary side, the pace of the stimulus must be reduced or risk high rates of inflation, which would destabilise the markets.

There has been too fast a change for an economy based on agriculture to one with an industrial heart and overheating is predicted – meaning far higher interest rates and accompanying inflation. In turn, this could develop into political unrest.

The urban private sector has not been helped by the same dimension as public. Reports of factory closures and migrant workers returning to the regions are legion.

Outwardly China is planning to show off its economic strength with the six months long Shanghai World Expo. The last time the world focused on the country to such an extent was the 2008 Olympics.

It will be keen to give an alternative image from its record on human rights with 68 crimes – including tax fraud and smuggling – carrying the death penalty. Some investors will ethically not support a regime which executes more people than the rest of the world combined.

Those who have bought into China have seen a roller-coaster over the past 12 months. The Hang Seng index has oscillated from 11,344 to 22,944 and is currently close to its highest point.

The yuan currency is artificially low and in an ideal world would not be pegged to the US dollar but Premier Wen Jiabao says China will not give in to foreign demands to let it rise.

Several different share classes are issued in China with 'A' restricted to local investors and qualified foreign institutional investors and 'B' available for foreigners, denominated in yuan and dollars (both US and Hong Kong) respectively.

With the difficulty of being able to analyse specific companies and deal in them, collective funds make sense. This also reduces the overall risk.

Three funds have consistently outperformed over both three and five years. On a net basis after charges, Lipper research reveals:

n First State China Growth up 92.4 and 301.2 per cent respectively;

n Fidelity China Focus A up 68.4 and 254.6 per cent respectively;

n Invesco PRC Equity up 64.1 and 229.2 per cent respectively.

Their consistency is encouraging. By comparison, Arc Capital lost 1.34 per cent over three years and HSBC with its vast knowledge of China only achieved 36.5 per cent growth over three years for its GIF Chinese Equity fund but 174 per cent over the past five years.

Neptune, a relatively small investment house with a good nose, also rather under-performed with its China A fund: up 40 per cent and 164 per cent over three and five years.

Some brokers, like Leeds-based Brewin Dolphin, are concerned that valuations in the short-term look high by comparison with the West. Martin Payne says: "Hot money flowed into the market last year and if this leaves on any short term global interest rate tightening, the market is vulnerable to correction."

Overall, Payne says, he is still a long-term investor in China and recommends it for at least five per cent of a portfolio. "However, it is not for the cautious or lower risk investor." He tips:

n First State China Growth invests in 40-50 stocks with manager Martin Lau currently favouring healthcare and utility companies and consumer sectors which he feels will benefit from high savings rates and growing incomes over the longer term.

n Gartmore China Opportunities hold around 70 stocks, currently weighted in favour of financials.

n Jupiter China whose manager Philip Ehrmann focuses on infrastructure and consumer stocks with notably property and utilities.

Jonathan Baker, investment manager at Charles Stanley stockbrokers in Leeds, likes First State China Growth and Jupiter China but also recommends:

n Aberdeen China Opportunities concentrates on quality Hong Kong listed companies with strong management in a Dublin based fund which is dollar denominated.

n Atlantis New China Fortune concentrates on mainland China with no Hong Kong or Taiwan exposure, using futures and trading tactically in large capitalisations

For an investment trust – which has the dual advantages of an independent board of directors and ability to borrow (or gear) when a good opportunity arises – JP Morgan Chinese is the obvious choice. The trust targets long-term capital growth and has a very good track record reflected in a small 1.5 per cent premium to net asset value.

Whilst this trust can gear up to 15 per cent, it currently has gearing around four per cent. It invests in Greater China equities, focusing on large caps. It is managed by JP Morgan's team in Hong Kong but they also make use of their joint venture with an asset manager in mainland China itself. Both Payne and Baker tip it.

Shortly details should emerge of a new Chinese fund to be run by star stockpicker, Anthony Bolton, who was head of Fidelity Special Situations for a successful 28 years. He has relocated to Hong Kong.

Another approach is to invest in an Asian Pacific fund with a fair proportion of its holdings in China. Consider First State Asia Pacific Leaders and Melchior Asian Opportunities but particularly Henderson TR Pacific Investment Trust, run by Andy Beal, which could be of the stars of this decade.

Finally, savers can gain exposure to China from companies that earn good trading revenues there. Look at drugs giant AstraZeneca or British American Tobacco or the miner BHP Billiton and several top Chinese firms are in fact owned by global companies like GlaxoSmithKline and Novartis.