East Asia has become a popular area in which to invest, with several hundred funds available to British investors that provide exposure to the Far East excluding Japan sector. Many of these funds have significant holdings in Greater China (mainland China, Hong Kong and Taiwan), which includes many mainland Chinese companies listed on other markets. But while interest in Chinese economic expansion continues, will investors also look to increase their exposure to companies listed in mainland China?According to some managers, while investing in the growth of China is appealing, several factors are leading investors to continue to gain their exposure to Chinese companies through other avenues, such as the Hong Kong market. Philip Ehrmann, head of Pacific and emerging markets at Gartmore, says that company management in mainland China is not yet as professional as it is elsewhere in the region. Until this begins to change, he says, with the exception of sophisticated investors, many will remain wary of investing directly in the country. Richard Sennitt, manager of the 51.3m Schroder Far East fund adds: “By buying on the Hong Kong exchange you get a greater level of confidence from the legislative and legal framework.” He adds that concern over profits in China, because of a margin squeeze caused by overcapacity, is also still present. “From a pure investment cycle perspective this is a fantastic period of economic growth, but we have seen a lot of overinvestment in China with a lot of margin pressure in industrials,” he says. Baring Asset Management also recently noted that investors should prepare for more reports of corporate malpractice in the country, because the Chinese government is making an effort to clean up the corporate sector. Broader mandates in the region, rather than dedicated Hong Kong or China funds, have also become popular with many investors in recent times. The HSBC Hong Kong Growth fund, for example, which was launched in 1985, changed its mandate and name two weeks ago. The change, which created the new HSBC Greater China fund, was made in order to expand the fund’s investment objective to include mainland China as well as Taiwan. According to Stephen Kam, Asia investment specialist for equities at HSBC, the group was responding to demand from investors for a broader greater China mandate, rather than a specialised single-country fund, which may have a less attractive risk profile. Gartmore made a similar move, says Ehrmann, first by converting its Hong Kong fund into a Hong Kong and China fund about eight years ago. The group subsequently rejigged the fund again, changing it into a China Opportunities fund. As at May 31, the Gartmore China Opportunities fund had 64% of its portfolio invested in Hong Kong and 36% in China. According to Greg Kuhnert, manager of the 22m Investec Hong Kong and China fund, the lines between the two markets are blurred at the moment because there are many mainland Chinese companies listed in Hong Kong. “A single market fund has limited appeal. When the market starts cooling, having a fund with a broader mandate is more appealing,” he says. Vanessa Donegan, manager of the 347.4m Threadneedle Asia Growth fund, adds that instead of investing in China as a country theme, many have chosen to invest indirectly in the country. This has been done through companies such as BHP Billiton or Rio Tinto, which supply much of China’s current demand for resources, as well as retailers in Hong Kong, which are experiencing growth from Chinese tourism, she says. However, one of the main reasons for many investors preferring to invest in China through companies listed in Hong Kong may have less to do with corporate governance than it has to do with restrictions. “At this point in time, the main reason we have not increased exposure to companies listed directly in China is the tax implications,” says Ehrmann. Apart from domestic investors, at present only Qualified Foreign Institutional Investors are permitted to invest in the Chinese A-share market, according to the China Securities Regulatory Commission. For fund management companies to qualify they must have been in operation for five years, with assets under management of $10bn (5.7bn). A-shares are domestically listed and traded in renminbi, while B-shares, which are Chinese companies listed on the domestic exchanges in American or Hong Kong dollars, are available to foreign investors. However, as at the end of 2003 there were only 24 companies with B-share listings compared with 1,146 on the A-share market, according to the CSRC. While Kam says the Chinese market is slowly being opened up, he adds it is not readily open to international investors. He says that because of the market restrictions on A-shares at the moment, HSBC focuses its investment in China on H-shares and red-chips. H-shares are companies incorporated in China but listed on the Hong Kong exchange, while red-chip companies are both Hong Kong listed and traded. Schroders’ Sennitt adds that it is difficult being an outsider with respect to A-shares. “As a regional fund manager you have had China, which is an economic powerhouse and has been expanding, but it has been very hard to get direct exposure,” he adds. Threadneedle’s Donegan adds that the A-share market has also recently been weak, with the MSCI China A index down 24.78% in the year to July 6, according to MSCI. Ehrmann, however, adds that “the valuations of A-shares are getting to be a bit more interesting.” According to Trustnet, the Far East excluding Japan sector is one of the top three unit trust/Oeic sectors in terms of performance over 12 months to July 6, returning 29.9%.