CLSA Global Emerging Markets has recommended investors reduce exposure to China Telecom (HK) and other key mainland technology stocks because their high valuations put them in the front line of fallout from rising interest rates. Strategist Peter Sutton said the three stocks that made up 80 per cent of the Morgan Stanley Capital International China Index - China Telecom, Legend Holdings and Citic Pacific - were riding high because of the technology stock boom. The counters' lofty valuations made them vulnerable in a rising interest rate environment. 'Higher rates should impact higher valuations proportionately more than lower ones,' Mr Sutton wrote in a research note to clients yesterday. 'China has a closed capital account but we don't think that provides protection when the ownership of these shares is foreign.' China Telecom shed 0.44 per cent to HK$56.25 yesterday, while Citic Pacific declined 2.67 per cent to $32.70. Legend rose 2.32 per cent to $8.80 China Telecom and Legend trade on higher valuations than any other stocks within CLSA's coverage of Asia's TMT - technology, media and telecommunications - sector. Legend, for instance, is trading on a earnings multiple for next year of more than 100 times, based on CLSA's estimated net profit. 'The massive valuation gap is not new news but it becomes more obvious as both long and short-term US rates continue to rise,' Mr Sutton said. However, CLSA's Internet analyst Benjamin Lo continued to support mainland plays in the TMT sector. Mr Lo yesterday reiterated a buy on Legend - adding, however, that valuations 'look stretched' - and also recommended the Nasdaq-listed Internet companies Sina.com and Chinadotcom Corp. CLSA said international fund flow to Asia had slowed, deterred by rising rates and the fallout from the rout in dotcom stocks. The trend led Mr Sutton to reiterate his recommendation that investors reduce holdings in Hong Kong, Singapore and Thailand. The mainland downgrade was a change of view. CLSA is not the only investment bank warning of the effects of higher interest rates. Salomon Smith Barney's Asian equity strategist Han Ong recommended total-return funds and other investors who were less able to withstand downside risks should shift their money into defensive stocks. 'Shorter term, it would be prudent to recognise the increased risk of financial-market contagion from overseas,' Mr Ong said in a strategy piece released on Monday.