Hong Kong rose to the forefront of the financial press in spectacular fashion this year as China region funds rallied to become the best-performing equity asset category worldwide, edging out gold and commodity sector funds during active December trade marked by heavy investment inflows. With only three trading days remaining in 2003, traders expect there will be little change in the performance charts, which also saw global technology funds rank third among more than a dozen equity classes tracked by Lipper, a financial services subsidiary of Reuters. Of the China region funds surveyed, Hong Kong received the single largest country allocation at 61 per cent, followed by Taiwan at 19 per cent, China at 15 per cent, Britain at 4 per cent and Singapore at 1 per cent. The heavy Hong Kong allocation adds to the belief that overall performance was driven by locally listed H shares, with the China Enterprise Index posting a return of 112 per cent by mid-December. Taiwanese shares also posted exceptional gains. 'It has been an overall phenomenal return for investors going into these regions,' says Lipper research analyst Tom Roseen. 'The China region is just short of doubling the amount of money these funds received from US investors in the past year.' At the start of the year, United States-based China region funds had invested assets of only US$582 million, or less than 1 per cent of the total US investible fund asset universe of US$3.5 trillion. In the 10 months to October 31, China region funds recorded net inflows of US$570.9 million, bringing the total net asset value of these funds to US$1.47 billion. In November these funds attracted a further US$235 million. Lipper compiled the data on US-based funds, but the information is seen as a generally good indicator of investment trends globally. Analysts say these positive US flows are a mere trickle when compared to the giant reservoir of dollars locked away in US equity and fixed-income funds. If the performance of China region funds continues to grab headlines, more dollars could head this way, fuelling what could be another banner year for China region equities in 2004, according to Lipper senior research analyst Don Cassidy. 'We would expect [US] fund flows to follow performance,' he says. 'US investors have some catching up to do in terms of rebuilding their assets and planning for retirement because of losses from the previous three years. Money is trickling back into equity.' Throughout the 10 months ending October, US-based equity funds attracted inflows of US$170 billion. That marks a sharp reversal of the US$20 billion of net outflow in 2000, the worst year for US funds since 1990. Mr Cassidy believes the positive performance of equities this year could put the industry on track to top the US$270 billion that US-based equity funds attracted in 2000. He adds that US investors may be undergoing a perceptual shift in thinking beyond its borders, a trend evident in the US$4 billion per month that US investors poured into global equity funds this year. 'They are sharply under-represented in world markets,' Mr Cassidy says of US investors. An estimated 25 per cent of dollars flowing into global equity funds are allocated to Asia. The investment backdrop during the next 12 months will be characterised by the fourth-year election cycle. At this point, the Federal Reserve usually takes a hands-off approach, Mr Cassidy says, implying that the central bank is likely to keep its monetary policy accommodative, with almost zero chance of any changes to the short-term interest rates beyond the half-year mark. 'The way the pattern typically works is that the third year of the presidency is the best (in terms of equity performance), and the fourth year is the second best,' Mr Cassidy says. For the year to November US$250 billion flowed out of US money market funds. Mr Cassidy says some of that reallocation can be attributed to investors switching into the equity funds as the outlook for the global economy improved in the wake of the Sars outbreak and the official cessation of hostilities in Iraq. But some investors may also be fleeing dollar weakness, he says. US indices are unlikely to match this year's rocketing performance, he says, pointing to a more reasonable target of 10 to 15 per cent upside. One trend to look for is better performance from large-cap stocks, which have tended to lag their smaller counterparts. 'The early leadership in small caps is played out,' he says. 'Money managers feel they cannot get enough room, and even though we look to 2004 for another up year, we do not envision a lot of advantage for growth over value.' He says early January profit taking could give clues to the year ahead, but with accommodative monetary policies from the Fed and projected deficit spending in the neighbourhood of US$500 billion, the odds favour stimulus-driven growth. Senior Lipper research analyst Andrew Clark believes US strength is positive for Asian equities, especially with signs of domestic-led growth appearing in countries such as India and Korea. 'Asia will outperform both the US and Europe,' he says. 'It is a good thing these countries are being driven more by internal demand than they are export growth.' He says most Asian currencies have risen slightly against the dollar, disproving the theory that Asian governments are trying to lock their currencies to the declining greenback to maintain export competitiveness. Look instead, he says, at a chart of the exchange rate of the yen and it becomes clear most Asian nations are keeping on eye on Tokyo. 'The Asian powerhouses have been very watchful of the Japanese,' he says. 'They certainly don't want to loose market share to the Japanese when it comes to selling to the Americans.' Another positive for Asian countries has been the strong performance of emerging-market debt. Mr Clark expects the sector to outperform US Treasuries again this year. Mr Clark says he is upbeat on the economic outlook, but has nagging worries. 'The risk here is that Fed policy stays very stimulative and we have a more severe bout of asset inflation, rather than the more friendly reflation,' he says.