Chinese dragon breathes fire that may burn unwary investor

The extraordinary economic transformation taking place in China has already created many investment opportunities; lots of money has been made but there have also been some spectacular losses, warns Chris Johns

Shares traded in Shanghai and Shenzhen have been prone to several boom and bust cycles. Direct investment in the Chinese economic miracle is not for the faint-hearted.

Even sceptical investors have to admit that an examination of the data coming out of China is a jaw-dropping experience. The economy probably grew by something close to 10 per cent last year while industrial production was up 17 per cent (annualised) in the second half of 2003. Imports grew at an astonishing 40 per cent pace during the same period.

I could go on making a list of remarkable statistics but the point has been made: China has been a growth story for some time and is one that shows no signs of ending any time soon.

These sorts of growth numbers will not be unfamiliar to observers of the Irish growth miracle of the 1990s.

The Irish economy also grew, for a while, at double-digit rates but the composition of that growth was often very different from the Chinese experience.

But the Celtic Tiger does offer at least one valuable lesson to those thinking about China: many commentators initially expressed doubts over the durability of the Irish growth story and, further along in the process, began to suggest that a bursting of the bubble was all but inevitable.

Similarly, we now see suggestions that China is overheating and that an inflationary boom and bust is just over the horizon. I think that these pessimists are going to be as surprised as the ones who forecast doom and gloom for the Irish economic renaissance.

Of course, we shouldn't push the parallels between China and Ireland too hard. China is about scale. The impact of its growth is being felt around the world in all sorts of ways.

The most recent and truly surprising side effect has shown up in Japan, where the economy grew at just over 7 per cent in the last quarter of 2003.

There were lots of reasons for this, but trade with China was one of them. Indeed, all over Asia we can see positive growth surprises popping up, to a greater or lesser extent driven by some aspect of trade links with China.

Even institutional investors sometimes avoid shares listed on the mainland. They tend to look at Chinese shares listed in Hong Kong - rules and regulations there are more familiar to Western investors and liquidity is generally better.

The many different types of shares available to investors, on both the mainland and in Hong Kong, are often a source of confusion, not least because the rules of the game can change, sometimes unexpectedly.

There are A and B shares, with different rules for domestic and overseas investors; H shares traded in Hong Kong; S shares in Singapore; N shares listed in New York. For anyone who has an appetite for direct holdings of Chinese companies, despite my strictures about risk, I would suggest a look at names such as Denway Motor, Beijing Airport and the oil sector. There will be lots more privatisation and other types of equity issuance in the coming years.

Personally, I don't think the time is yet right for the individual investor to own direct stakes in Chinese companies.

Apart from corporate governance issues there is a simple matter of timing: H shares, for example, rose 150 per cent during April to December 2003 (but have fallen back a touch this year).

There are other ways of investing in China that afford fewer sleepless nights. Trusting your money to an institution via an investment trust or similar vehicle is the simplest route. Alternatively, the private investor could look to companies elsewhere in Asia that are listed on more familiar exchanges.

The whole of Asia is now a growth story, not only because of the impact of China.

India is also beginning to show signs of replicating the Chinese experience. For anyone who wants to buy into this, the simplest way, again, is to invest in a unit trust-style product.

But there are also opportunities closer to home. Many FTSE 100 (and other European) companies have Chinese and Asian exposure.

Clearly, banks such as HSBC and Standard & Chartered have extensive Asian operations. Mining and commodity stocks such as UK-listed BHP Billiton have been doing very well lately, with rising commodity prices being driven by voracious Chinese appetite for just about every basic resource imaginable.

Sceptics argue that commodities and mining stocks will collapse when the Chinese bubble bursts. If they are wrong, then we will see companies such as BHP Billiton continue to do well.

Even boring old oil stocks such as BP could benefit if Chinese imports keep oil prices higher than expected.

Investment bankers are looking to China as an important revenue generator: in the US, it seems to me that Morgan Stanley is going to be a major beneficiary of any further development of China's capital markets. The story about Asian growth provides the most important lesson about investing in China.

We do not need to go to the relatively illiquid Chinese stock exchanges with their less than transparent codes of governance to gain exposure.

The direct purchase of Chinese listed companies could make you a lot of money but it is also likely to be a very uncomfortable roller coaster ride along the way. There are far less stressful ways of investing.