INVESTING China-region funds offer big returns but high risks

China-region funds offer promising returns if investors can stomach risk.
NEW YORK (AP) -- Lured by the promise of China's growing economy, many investors are turning to mutual funds geared specifically toward investments in that region. But advisers warn that the potential for big returns comes with high risks and volatility.
China-region mutual funds typically invest in mainland Chinese companies, although they can also include businesses in Hong Kong, Singapore and Taiwan.
So far in 2003, the nine funds tracked by Lipper Inc. have been returned about 56 percent, compared with a little more than 20 percent for the Standard & amp; Poor's 500 index and 27 percent for Japan funds.
The performance by China-region funds was competitive with gold funds, which surged 62 percent, and tech funds, which climbed 55 percent. Latin America funds, another strong emerging market sector, trailed at 47 percent.
Investors have responded, tripling net inflows into China-region funds since March, according to Lipper. Total assets have jumped from $582.5 million at the end of 2002 to 1.5 billion through October, partly due to market appreciation of the shares.
What's behind popularity
Analysts attribute the funds' popularity to growing investor interest in higher-yielding foreign investments.
Market reforms in China in the last decade have spurred fast economic growth while Japan, the traditional Asia powerhouse, has struggled with bouts of deflation.
"After three years of a bear market here, and with people losing confidence in the U.S. dollar, investors started looking abroad," said Romeo Dator, portfolio manager for U.S. Global Investors. "In terms of its overall growth, China is really in its early stages."
Indeed, the U.S. trade deficit with China stood at $103 billion last year and is headed for $120 billion or higher this year as Americans snapped up lower-priced Chinese goods.
But analysts caution that China-region funds might have already seen the best of their gains, with more modest returns anticipated in 2004. In the meantime, the emerging market investments tend to be volatile, with large price swings.
Ups and downs
"People look at these funds and see them up 20-30 percent over four, five or six months and say, 'Wouldn't it be great if they kept doing that,"' said Bill Rocco, senior analyst at Morningstar Inc.
"But the funds are more like stocks from a risk-reward profile," he said. "They're not very diversified. To focus on one region is very risky, let alone one country. It can do quite well, but it also can lose a lot of money very quickly."
Analysts cite several risks:
UA new outbreak of SARS. The deadly virus, which first appeared in southern China in November 2002, stifled tourism throughout the region as it sickened thousands of people on the mainland, Hong Kong and Taiwan. A SARS re-emergence could quickly dampen economic growth.
UInflation of China's currency. U.S. manufacturers have argued the yuan is artificially depressed and should be allowed to float in relation to other currencies. If so, that would push up the value of the yuan, at least at first, making Chinese exports more expensive.
UTrade wars. The Bush administration, facing increasing pressure from U.S. businesses to stem the wave of Chinese goods, put quotas on certain Chinese textiles and apparel last month and is threatening to levy duties on Chinese television sets. Further restrictions could decrease Chinese profits.
UTensions with Taiwan. Taiwanese President Chen Shui-bian has called a March 20 referendum that China sees as a dangerous step toward independence. Escalation of the conflict could spark war and draw a reluctant United States into the fray.
Monitor quarterly
Still, financial advisers say China-region funds remain good prospects -- Dator predicts the sector will outpace the S & amp;P 500 in 2004 -- but investors will have to monitor their performance quarterly since political and economic conditions can change quickly.
For investors nervous about the volatility, options include buying into an Asian region fund or a more generic international fund, which typically has 10 percent in emerging markets such as China but also more stable investments to minimize price swings.
Other factors to consider are fund expenses, since international funds can be pricey, and a fund company's protections against short-term trading, because market timers often seek to take advantage of time differences to garner quick gains at the expense of longer-term investors.
"With 1.2 billion people, China is still a good market to look at," said Tom Roseen, research analyst at Lipper.