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SCMP Reporter

Investors have been warned they risk getting their fingers burnt in the mania for red chips.

 These Hong Kong-based companies controlled by mainland agencies have been riding high on expectations of asset injections from their parents and an influx of mainland funds.

 The Bloomberg red-chip index is up 21.4 per cent to 238.92 points on the year to date, against the Hang Seng Index's rise of 2.85 per cent.

 Emerging markets specialist Mark Mobius is not among the sector's patrons.

 'It's like a guessing game,' said Mr Mobius, the president of Templeton Emerging Markets Fund Inc, which has US$2 billion set aside to invest in Hong Kong stocks.

 Buying on hopes of asset injections was risky as little was known about what assets were to be injected and at what prices, he said.

 Even if the Chinese Government tried to bring down the market, people would buy in the belief that the assets would be there.

 'That's why it is very difficult to predict what could happen, especially for something that goes up that fast, because it's not healthy. You've got to be careful,' Mr Mobius said.

 If the government was to prohibit mainland money from buying red chips or prohibit red chips from getting asset injections, 'the whole red chip business will be finished', he said.

 The financial community may have divergent views on whether the red-chip upswing has peaked, but the consensus is that the sector is vulnerable to any negative news at these high valuation levels.

 Recurrent rumours that China's economic czar Zhu Rongji is concerned about the sector shaved several per cent off those counters on Monday this week and the previous week.

 The sector is expected to remain volatile in the near term as people speculate on what measures Beijing will take to cool down the frenzy and to regulate red chips.

 'Any move or news is set to trigger a crash, albeit a small one, at these lofty valuation levels,' a market observer said. 'The speculative buying of red chips has been overdone.'  The resurgence of red chips could be seen as an auspicious sign ahead of the handover but it could also prove destabilising, another observer said.

 Assistant director at ABN Amro Hoare Govett Asia Eddie Lau said: 'The recent rally was liquidity-driven. Any negative reports are bound to push share prices down at this level of valuations as investors are willing to take profit.'  Investor attention would switch from existing red chips, which are trading at about 30 to 40 times earnings, to a continuous supply of new listings priced at about 12 times earnings.

 HSBC James Capel analyst Alex Fan said he was bullish on the overall red-chip sector over the next three months on expectations of more asset injections.

 China was unlikely to introduce measures that would have a grave impact on the sector before the handover, he said.

 There might be periodical consolidations but he did not see any major reason why the sector would crash.

 Smaller red chips, which had been driven up on groundless expectations of asset injections, were an exception.

 'People will still buy the asset-injection story because it is China where the opportunities lie. There is no reason why red chips have to rely only on organic growth, which is limited,' he said.

 Not all asset-injection stories would deliver, though.

 Considering possible future restrictions, market watchers advised investors to stick to the big guns, particularly those which were politically connected.

 ING Barings head of China research Hoong Yik Luen said: 'The Chinese authorities are unlikely to rein in the asset injection spree for fear of destabilising the Hong Kong market.

 'Stay with the politically strong red chips, such as those belonging to the ministries, key municipal governments or the People's Liberation Army. The current confusion as to which body approves asset injections will probably only hurt the politically weaker players.'  State Council Securities Policies Committee member Hong Hu said recently that the China Securities Regulatory Commission (CSRC) should concern itself with new listings of red chips instead of spin-offs and asset injections.

 The spin-off of Chaozhou Industries from Guangnan (Holdings), controlled by the Guangdong provincial government, is awaiting approval from the CSRC. Its float was originally scheduled for late March or April.

 Some have suggested the CRSC may want to curb listings or spin-offs of smaller and weaker red chips because they have become speculative vehicles whose performance may affect the sector's image.

 Raymond Chan Chi-keung, associate director at BZW Investment Management Hong Kong, which manages the US$36 million Barclays ASF China Fund, said it would maintain its overweight position on selected red chips.

 He said the sector's recent correction was healthy as it had risen too fast.

 Billy Chan, investment manager at LGT Asset Management, said that selected red chips were still worth buying and holding, considering their solid fundamentals and good earnings growth prospects.



Investors warned to beware growing red-chip fervour