Under today's uncertain economic conditions, some good buys can be found among middle-sized industrial stocks listed in Hong Kong, according to Chung Man-wing, managing director of the Pacific regional group for JF Asset Management. He believes Hong Kong and Taiwan-listed manufacturers selling into US and European markets will continue to benefit from the global outsourcing trend in manufacturing. This factor helps to offset an otherwise gloomy economic picture. 'In terms of the economy, we are still clearly struggling in Hong Kong, in terms of high unemployment, the continued deflationary spiral, and there is still a very low level of domestic investment and consumption,' he said. Looking ahead over the next 12 months, he foresees three positive developments. The weaker US dollar, which could strengthen the local economy; a successfully reflated US economy, which would stimulate demand in that country; and China's continued economic development. 'From my point of view, the development in China looks like being the most secure of these positive factors. That must be very good news for low-cost manufacturers that are producing in China using its lower costs of production and exporting to the rest of the world, particularly the US and euroland,' he said. Mr Chung said China's accession to the World Trade Organisation and the recent Closer Economic Partnership Arrangement (Cepa) deal with Hong Kong were two stimulants to the industrial sector. 'The mid-cap industrial stocks that are listed in Hong Kong, and increasingly in Taiwan, are almost classic examples of winners. They are beneficiaries of the outsourcing trend. On average, their share prices have performed very well over the last 12 to 18 months, partly on their own merits and partly because large local blue chips are struggling to produce returns and further increase their profitability.' Despite this strong recent performance by the mid-cap industrials, their earnings momentum remained strong and their current valuations reasonably priced, he said. 'We continue to be able to identify reasonably valued stocks with very powerful earnings momentum going forward, at least for the next 12 to 24 months.' Among other funds, Mr Chung manages the JF Greater China Absolute Return Fund, the first hedge fund authorised for retail investors by the Securities and Futures Commission. At the end of June, the Absolute Return Fund was more heavily weighted towards long positions at 67.2 per cent of its holdings, like most traditional funds which stand to benefit when prices rise. Almost 25 per cent was allocated to short positions, a tool used by hedge fund managers betting stock prices will fall. Mr Chung said the allocations partly reflected his group's market views but were also related to the structure of mainland China's markets, where short positions were often difficult or impossible to achieve. During the Sars outbreak, Mr Chung and colleagues talked to the managers of companies within the portfolio, asking about the likely impact of Sars on their business. 'The general conclusion from those calls was that Sars had no impact on manufacturing based in China and exporting to the rest of the world, whether Hong Kong-listed, mainland- or Taiwanese companies,' Mr Chung said. 'We were quite encouraged by that and took the opportunity to increase our (long) exposure to these stocks.' At the same time, Mr Chung said he became more concerned about the prospects of domestic Hong Kong consumption and investment. 'We saw reason to be worried about economic recovery and corporate profits among the blue chips, including banks, property companies and retailers. We took the opportunity, wherever we could, to put in a couple of short positions on a couple of pure Hong Kong domestic asset plays.' The fund was 54.6 per cent invested in equities or equity derivatives at the end of June, of which the biggest portion, 25.7 per cent, was in industrials and 23 per cent in materials-related stocks or derivatives. The Absolute Return Fund has returned about 15 per cent since it was launched in December last year. Illustrating the outperformance of long-only funds during a rise in equity markets, as of July 24 two other long-only equity funds managed by Mr Chung had performed strongly. The JF Greater China Fund had returned 31.8 per cent year to date and 15.6 per cent over 12 months, while the JF Hong Kong Fund returned 30.1 per cent so far this year, and 20.7 per cent in 12 months. Both funds were launched in May 2001. Mr Chung said investors in long-short hedge funds needed to be aware they were making a trade-off between risk and return. Unlike a straight long fund, the Absolute Return Fund would never capture all of the equity market's upward movement, because of its short positions. But these short positions also provided a buffer in times of falling markets. PROFILE 1987: BA (economics), University of Pennsylvania 1990: Thornton Management (Asia) 1992: East Asia Hamon Asset Management 1993-2000: HSBC Asset Management Hong Kong 2000-2002: Director and head of the Greater China team, Jardine Fleming Investment Management 2002: Managing director, JPMorgan Fleming Asset Management