Getting Ready for a New Hong Kong Investing Game

Want to place a bet on the Hong Kong stock market? Then choose carefully, take a deep breath and hold on for what promises to be a wild--but potentially profitable--ride, according to analysts on both sides of the Pacific.

With just three weeks remaining before the crown jewel of Britain’s faded colonial empire returns to China, speculation abounds as to whether this Asian financial capital will survive under its new Communist masters.

Yet nowhere is optimism more apparent than at the stock exchange of Hong Kong, Asia’s second-largest stock market, where investors have been throwing their money like there’s no tomorrow at new listings of “red chips”--mainland China-backed Hong Kong companies.

Red-chip gains and strength in Hong Kong’s own blue chips have fueled a 17% surge in the benchmark Hang Seng stock index since the end of March. The index hit a record high of 14,990 on June 2, and has since eased back to 14,655--still up 9% year-to-date, and up about 33% from a year ago.

Like many money managers, Richard Farrell, head of the Asian equity desk for Guinness Flight, a London-based investment group (see accompanying story) is skeptical about some of the more hyped red-chip issues. But he remains bullish about the long-term potential for the Hong Kong market.

Farrell acknowledges that the political climate may change, but he also thinks Hong Kong companies are uniquely positioned to profit from the marriage of Hong Kong’s hyper-efficient business infrastructure with southern China’s low wages and inexpensive real estate.

“We believe there’s every chance that the combination of southern China and Hong Kong . . . will turn out to be the jewel in the crown of Asia both in the long term and in the relatively short term as well,” said Farrell, whose Guinness Flight China & Hong Kong Fund has invested 97% of its money in Hong Kong stocks.

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Most Hong Kong-based companies, whether multinationals or locals, are increasingly betting their future on opportunities across the border. And mainland companies are coming to the Hong Kong market to raise capital.

After July 1, there will also be a growing number of mainland Chinese individuals pumping billions of dollars in pent-up savings into the Hong Kong market because it is regarded as much safer than the newly created Chinese exchanges, according to Richard McConnell, author of a new book, “The Investment Opportunity of a Lifetime--Hong Kong 1997 and Beyond.”

“Can you imagine what will happen when $600 billion starts looking for a place to invest?” asked McConnell, a private investment manager. When the Hong Kong stock market reopens July 3 after a five-day holiday, some things are expected to not have changed.

Since the Hong Kong dollar will still be pegged to U.S. currency--at a rate of about $7.80 Hong Kong to $1 U.S.--the market will remain sensitive to interest rate fluctuations in the United States.

The Hong Kong Stock Exchange will also remain heavily influenced by real estate prices, with firms closely tied to the real estate industry accounting for 60% of the market, according to Michael Green, a property analyst with Salomon Bros. in Hong Kong.

After a slump a few years back, the land-starved colony has once again become one of the most expensive real estate markets in the world, leading some to worry about a speculative bubble. Last year, luxury apartment prices soared 40%.

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And the Hong Kong stock market has never been a place for the weak at heart, given its history of drastic swings. In the wake of Wall Street’s 1987 blood bath, the Hang Seng index of 33 leading Hong Kong stocks plunged 50% and trading was halted for a week.

Just as the market started to improve, it took another hit when the Chinese government sent its tanks into Tiananmen Square on June 4, 1989. But in this decade, the market has climbed steadily.

Even veteran market watchers like Green, who has lived in Hong Kong since 1989, are working overtime to keep up with the market this year. After slumping 7% in the first quarter it has rocketed since as money has poured back in.

“In the shorter term, this high degree of volatility often does exert pressure on small investors,” Green said. “If investors want to get exposure in this market, they should take at least a five-year view, rather than trying to get rich quick overnight.”

Of all the Asian markets, Hong Kong is considered one of the best to invest in directly, because its stock exchange is closely regulated and highly transparent. But buying directly into the market from the U.S. means paying extra fees and taking on far greater risk, because it is difficult to monitor such a volatile market from afar.

A handful of Hong Kong stocks, including Asia Satellite Telecommunications Holdings Ltd. (ticker symbol: SAT) and Hong Kong Telecommunications Ltd. (HKT), trade in the U.S. as American depositary receipts, or ADRs. Those stocks trade like stocks of U.S. companies.

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But for U.S. investors, particularly those new to the region, the easiest way to invest, analysts say, is in one of the dozen or so U.S. mutual funds focusing on the region.

One argument for getting into the stock market now is the continuing “Hong Kong discount,” which means its stocks still are cheaper than many comparable stocks elsewhere in the world. Whereas the average Asian stock is selling for 15 to 20 times estimated 1997 earnings, Hong Kong shares typically sell for 10 to 15 times estimated 1997 earnings, reflecting investors’ concerns about the city’s future.

“We see a lot of that discount on the Hong Kong market disappearing after 1997,” said William Overholt, managing director of Bankers Trust Co. in Hong Kong. “I would advise them [investors] to get in before July 1, because when the Hong Kong market moves, the train leaves quickly.”

Thomas Tuttle, managing director of Newport Pacific Management in San Francisco, expects the hand-over to be followed by a boom in spending as China’s leaders look for ways to prove to the world that they can keep their golden goose alive and healthy.

That should translate into increased spending on giant infrastructure projects, such as new roads and the new Hong Kong airport at ChekLap Kok, at the same time that hundreds of new mainland Chinese companies are expected to enter the Hong Kong economy.

That is particularly good news for Hong Kong property developers and construction firms with interests on both sides of the border, such as Cheung Kong Holdings Ltd. and New World Development.

“We don’t see from this level a great amount of downside risk,” Tuttle said. “This is probably one of the more positive periods of time we’ve seen in our 22 years of watching Asia.”

Nonetheless, investors must remember there is risk. A key reason for the “Hong Kong discount” is uncertainty over how much China will manage the Hong Kong economy. If the economy falters, the stock market may do the same.

While it is already clear that the traditional British-dominated blue-chip companies are going to lose their favored position after July 1, they remain a haven for fund managers seeking the safest way to cash in on the Hong Kong phenomenon.

Gary Greenberg, deputy managing director of Peregrine Asset Management in Hong Kong, said that Swire Pacific Ltd., part of one of Hong Kong’s traditional British hongs, or trading companies, represents a good buy in the present bull market.

Greenberg, who manages five investment funds with total value of approximately $130 million, oversees the Peregrine Asia Growth Opportunities Fund, the Peregrine Premier Asian Growth Fund and the Peregrine Hong Kong Fund.

“The value obviously lies in the blue chips,” he said. “The Swires, in particular, look very inexpensive at 10 times earnings. They’ve got good China connections, a good spread of business and good management.”

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Tuttle--whose family of funds will soon begin offering the Colonial Newport Greater China Fund with a focus on China and Hong Kong--is also a fan of taking a “conservative, blue-chip” approach to his overseas portfolios.

In Hong Kong, he is a fan of Hang Seng Bank Ltd., a mid-size subsidiary of the Hong Kong and Shanghai Bank with a strong position in the mortgage market. Another recommended stock is Hong Kong & China Gas Co., a provider of residential gas and appliances, which has outperformed the rest of his Hong Kong holdings.

But recently, Tuttle has begun moving more aggressively into the top tier of the red chips, those mainland-backed Hong Kong companies loaded up with undervalued mainland China assets.

Those include Citic Pacific Ltd., a subsidiary of the mainland’s powerful China International Trust & Investment Co., and Guangdong Investment Ltd., which is controlled by the government of neighboring Guangdong province, one of China’s wealthiest regions.

Analysts warn against getting swept away by red-chip frenzy. Take Beijing Enterprises Holdings Ltd., a Beijing government-backed company that owns a mishmash of businesses including the local McDonald’s franchises. When it went public on May 29, it was more than 1,200 times oversubscribed and had more than tripled its listing price.

Red chips have become the darling of the Hong Kong market because they are believed to be the safest way to capitalize on the dramatic growth in the Chinese economy.

But Robert Medd, a Hong Kong analyst with Deutsche Morgan Grenfell, urges caution.

“I am very much a fundamental value-growth type investor,” he said. “Personally, I think there is far too much optimism built in [to the red chips]. I like to see things being valued based on what is achievable in the next six months, rather than which is achievable in the next 10 years.”

David Chambers, director and portfolio manager of the Los Angeles-based Hotchkis & Wiley International Fund, is also a bit worried by the red-chip and real estate froth.

With a few exceptions, such as China Light & Power Co., which Chambers describes as a well-managed government utility with good ties to the Chinese government, he advises waiting for a correction in the Hong Kong market, which he believes will occur sometime in the next six to nine months.

“It will come either because of rising U.S. interest rates or would come from an introduction of measures by the Hong Kong government to try and cool down the property markets further,” he said. “I don’t expect a collapse of the market but I think it might provide a better buying opportunity.”

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Times staff writer Evelyn Iritani can be reached at evelyn.iritani@latimes.com

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Placing Bets on Hong Kong

Fund tracker Morningstar highlighted 10 funds in a report released Friday, each with a different exposure to Hong Kong- and China-based companies. Also shown are four primary indexes--covering the Hong Kong stock market, so-called red-chip shares and two major Chinese stock markets.

INDEXES

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% of assets in: Total return (June 6) Hong Kong China YTD 1-year Hang Seng Index 100% 0% 8.95% 30.89% Bbg Red Chip index* 100 0 50.69 141.55 Shanghai A-Share index 0 100 39.39 66.39 Shanghai B-Share index** 0 100 28.52 19.12

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*BBG Red Chip is the Bloomberg Hong Kong Red Chip Index.

**B shares are for foreign investors only.

FUNDS

Wright Equi-Fund Hong Kong

% of assets in Hong Kong: 100%

% of assets in China: 0%

Total return (June 6) YTD: 5.46%

Total return (June 6) 1-year: 24.10%

800 number for open-end mutual funds: 888-9471

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Guinness Flight China & Hong Kong

% of assets in Hong Kong: 97

% of assets in China: 3

Total return (June 6) YTD: 8.20

Total return (June 6) 1-year: 30.30

800 number for open-end mutual funds: 915-6565

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Fidelity Hong Kong & China

% of assets in Hong Kong: 95

% of assets in China: 1

Total return (June 6) YTD: 9.40

Total return (June 6) 1-year: 38.00

800 number for open-end mutual funds: 544-8888

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Greater China Fund (closed-end)

% of assets in Hong Kong: 78

% of assets in China: 17

Total return (June 6) YTD: 20.98

Total return (June 6) 1-year: 45.17

ticker symbol for closed-end funds: GCH

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Templeton Dragon (closed-end)

% of assets in Hong Kong: 73

% of assets in China: 14

Total return (June 6) YTD: 2.07

Total return (June 6) 1-year: 29.27

ticker symbol for closed-end funds: TDF

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Templeton China World (closed-end)

% of assets in Hong Kong: 69

% of assets in China: 19

Total return (June 6) YTD: 3.77

Total return (June 6) 1-year: 31.16

ticker symbol for closed-end funds: TCH

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Ivy China Region

% of assets in Hong Kong: 62

% of assets in China: 18

Total return (June 6) YTD: 10.20

Total return (June 6) 1-year: 20.89

800 number for open-end mutual funds: 456-5111

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China Fund (closed-end)

% of assets in Hong Kong: 56

% of assets in China: 40

Total return (June 6) YTD: 25.71

Total return (June 6) 1-year: 36.96

ticker symbol for closed-end funds: CHN

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Jardine Fleming China Region (closed-end)

% of assets in Hong Kong: 55

% of assets in China: 30

Total return (June 6) YTD: 25.56

Total return (June 6) 1-year: 30.12

ticker symbol for closed-end funds: JFC

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United Services China Region

% of assets in Hong Kong: 38

% of assets in China: 46

Total return (June 6) YTD: 13.00

Total return (June 6) 1-year: 37.60

800 number for open-end mutual funds: 366-5465

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Sources: Morningstar, Bloomberg News