Question Marks Mar Hong Kong's Plan for Unit Trust

HONG KONG -- What if Warren Buffett owned 10% of all the stocks in America and announced he was going to unload three-quarters of his position by the end of the year? Chances are, investors would stampede to the exit.

In Hong Kong, where you can substitute "the government" for "Warren Buffett," the benchmark Hang Seng index actually jumped 4% in June when authorities announced they would sell the shares they accumulated a year ago to defend the island's financial markets.

Hong Kong investors buying into what seems like a sure glut of shares are not as crazy as they might seem, although foreigners might want to think twice before following the locals' lead. Many of the island's investors believe the government won't sell enough stock to crater the Hang Seng. That belief was reinforced after T.L. Yang, the official in charge of the sale, said his main objective is to unload the shares "without disrupting the market" or causing a return to the panic the rescue operation helped to end last year.

Although that's a tall order, the Hong Kong government has a vested interest in maintaining market order. It's sitting on capital gains of more than 70% from a year ago this month, when panic over the Asian crisis and the collapse of the Russian ruble put severe pressure on this former British colony's stocks and its fixed currency.

Hong Kong's unprecedented -- and controversial -- intervention in the market began as limited support for all 33 stocks in the Hang Seng, but it soon veered out of control when sellers realized they were looking at a nice one-way bet. By Aug. 28, the government was almost the only buyer in the whole market on a day of record volume. After every willing seller had unloaded, the authorities had spent $15 billion of taxpayer money.

This past June, Yang said that most of the holdings would be put into a "unit trust," the U.K. equivalent of a mutual fund, to be traded on the local exchange and made affordable for retail investors.

Beyond that, "we've really got no clue what exactly they're going to do," says Anil Daswani, head of Hong Kong research at Salomon Smith Barney. That goes for what kind of fund will be launched, when the government will launch it and how big it will be initially.

Because mutual funds in Hong Kong have a penetration rate of just 5% and index funds in Asia are especially unpopular, the speculation in Hong Kong is that the government will offer income-tax breaks to local investors who buy in. That may entice Hong Kongers, but it may prove little incentive for overseas investors with an interest in the island.

Such a setup would in effect be a closed-end fund, says Stewart Aldcroft, marketing director at Templeton Franklin in Hong Kong. Closed-end funds issue shares that rise and fall based on the underlying value, or net asset value, of the fund's holdings. While locals might get a discount on the NAV, there's no word whether the same bargain will be extended to foreigners.

In the end, overseas investors keen on Hong Kong stocks might be wise to give the new fund a miss, at least at first. Regardless of government mutterings, any sizable offering will probably depress the market, especially because Hong Kong stocks are already back at precrisis levels, even though the economy is still deep in recession. The Hang Seng is up 78.5% during the past 12 months, although it is still 22.5% from its all-time high.

More importantly, when it's time to buy, investors can mimic the Hang Seng easily on their own. Banking giant HSBC (HSBHY Quote) makes up about a quarter of the Hang Seng and now trades in New York as well as in London. Throw in the other Hang Seng heavy hitters, conglomerate Hutchison Whampoa (HUWHY Quote), Sun Hung Kai Properties (SHGKF Quote) and China Telecom (CHL Quote), and close to half the index is represented. Plus, these holdings would have broad exposure to banking, real-estate shipping and telecoms, which is what Hong Kong is all about.