Investors cautioned not to overindulge on mainland-listed Chinese equities

As the Chinese Year of the Pig begins, the manager of Edinburgh Dragon Trust plc, Jeremy Whitley, cautions investors not to overindulge on mainland-listed Chinese equities.

China’s economy raced ahead by over 10% in 2006, while the Shanghai Stock Exchange Composite posted an impressive US dollar return of over 140%, rebounding after three years of poor performance. The Year of the Dog also saw a number of IPOs, most notably by banks and insurance companies such as Industrial and Commercial Bank of China (ICBC) and China Life Insurance.

The wave of Chinese new issues has been devoured by hungry investors, but Whitley has been wary of this trend. “Few new listings have met our quality criteria,” he says, “yet some have reached astronomical valuations since coming to market. One example is ICBC, China's largest lender. The dual Hong Kong and Shanghai-listed financial’s market capitalisation is now equivalent to that of global banking giant HSBC.”

Thanks to investors’ insatiable appetites and the glut of IPOs, mainland equity valuations have ballooned. But sooner or later the weaker fundamentals of many mainland-listed companies are going to show through, as investors realise that these companies’ earnings aren’t growing as strongly as China’s economy. Given the potential volatility of the mainland stock markets, as well as concerns about corporate governance and management quality, Whitley cautions investors not to gorge impulsively on shares in local-listed companies. That said, the rapidly growing size and depth of China’s domestic stock markets shouldn’t be ignored either. Aberdeen’s Asian equity team, of which Whitley is a member, continues to research mainland-listed Chinese equities, in the quest for companies that meet its quality criteria.

Meanwhile, as the mainland market develops, Chinese growth still offers the more discerning investor some tempting opportunities. At the moment Whitley prefers to access the country’s growth potential via Chinese companies listed in Hong Kong, or Hong Kong-listed companies with operations in China. “These companies have higher standards of management, accounting and transparency than their mainland-listed counterparts, and for top-calibre companies with exposure to China, earnings growth potential is substantial,” says Whitley.

Due to the ongoing optimism about the outlook for growing domestic demand, Aberdeen remains overweight financial and consumer companies. With this in mind, as the Year of the Pig begins, the China-focused investor need not go hungry, because Hong Kong offers rich pickings. Companies such as mid-size financial Wing Hang Bank and China’s largest mobile telephone operator, Hong-Kong-listed China Mobile, are ideally positioned to profit from the rise of the Chinese consumer.

Jeremy Whitley, Manager of Edinburgh Dragon, comments: “We remain conservative on China mainland-listed companies, believing that the Hong Kong market still offers better opportunities in terms of quality and corporate governance, along with a more stringent regulatory environment. Meanwhile, the valuations of mainland-listed companies are looking increasingly stretched, suggesting that the stock market is due for a pause.”