Investors are taking a more pragmatic view of the mainland despite the economic improvements For a sign of the popularity of China-theme investments these days, look no further than the recent offering by HSBC, which attracted US$153 million of new investment into its China Momentum Fund in February. Initially aiming to raise just US$100 million, the bank raised the public draw because of the overwhelming response. The fund's manager, Richard Wong, admits he was surprised, but says there are no uncomfortable associations with the heady days of 1997, when public interest in China shares reached fever pitch. He thinks investors have a more pragmatic view of the mainland even though it is a much improved ship economically - 'we think there is a lot of caution in the market towards China'. By several measures, he says, China looks much better than it did eight years ago. Return on equity, for example, has risen from about 3 per cent in 1998 to 14 per cent. Dividend payouts have jumped from 15 per cent of earnings to 30 per cent. The level of state ownership in industry has fallen sharply and the China share universe is now well beyond the teething stage in dealing with free-market reforms. The China Momentum Fund was launched in October, with an initial size of US$53 million. During the past seven months the fund is up about 32 per cent versus 9 per cent for the MSCI China index. It is a smaller and more nimble cousin to HSBC's main China equity-fund vehicle, launched in 1992 and with a fund size of US$1.6 billion. The mandate of the Momentum Fund is to invest more than 70 per cent of its assets into the three classes of mainland shares, A and B shares listed in both Shenzhen and Shanghai, and H shares listed in Hong Kong, and other major markets. Despite the popularity of the China investment story and the dramatic expansion of liquidity within its borders, relatively little money has been flowing into the domestic share market. Mainland investors have been steering clear in part due to the overhang of government-owned shares. About two-thirds of the 1,300 stocks listed on the domestic A-share market are held by government or state-owned enterprises. The general weakness, reflected in the 50 per cent collapse of the Shanghai index since 2001, can be attributed partly to fears the government will unload these shareholdings in keeping with its goal of reducing state ownership. The declines have shrunk the trading premium of A shares from 80 per cent over H shares to less than 40 per cent. New rules that make it easier for mainland investors to purchase H shares through Hong Kong are expect to further cut the price discrepancy. 'We expect the convergence of the valuation will continue, but we have already seen the bulk of the consolidation,' Mr Wong says. 'We realise that the general market valuation is much higher in the A shares, but we do find some good investment opportunities which are not available in the H-share or B-share market.' Among the potential winners is a Shanghai-listed A share geared towards China's growing affection for cars. Fuyao Glass is the largest vehicle window supplier in the mainland, controlling a 60 per cent market share. While it is true that China is suffering from a glut of car-industry manufacturing capacity, Mr Wong says Fuyao has a defensible market share. 'Because of their strong position they are able to maintain their margins,' he says Another company that meets the criterion of fast growth and a defensible market is Shanghai Container Ports. Last year it had a 29 per cent increase in throughput, making it the world's third busiest port after Hong Kong and Singapore. Also among the fund's holdings is Shanghai International Airport. This company is leveraged on China's booming exports (up 35 per cent last year) as well as the rise of the north as the commercial and economic heartland. He says the valuation is not excessive with a price/earnings ratio in the high teens - reasonable given the growth outlook. China Shipping Development is a bet on China's voracious appetite for commodities. As the dominant player in the shipment of oil and coal in mainland waters, its growth outlook is bright, Mr Wong says. He also sees Cosco Pacific and China Merchants as strong candidates. The fund also plans to bolster its core position in PetroChina, CNOOC and Sinopec. 'We like companies in good stable growth industries with high entry barriers,' he says.