Bigtime Investors Lose Big on China

NEW YORK (TheStreet) -- There's an argument to be made that no one played a bigger role in popularizing Chinese small-cap stocks for widespread consumption than the smart money -- the boldfaced fund managers whose names and faces are always splashed on the covers of the financial magazines. When they started to buy big stakes in what had been obscure little companies doing business in remote corners of the People's Republic, the world took notice.

It helped, of course, that these companies were growing so fast that it was almost hard to believe.

Almost.

That growth was being documented, after all, right there in black and white in the companies' filings with the Securities and Exchange Commission.

Plus, there were all those long lunches and dinners over which American investors got acquainted with charismatic company chairmen and chairwomen in the restaurants of Harbin or Shanghai or Shenzhen or Xi'an. Plus, there were all those due diligence tours of bustling factories and offices and operations -- tours always arranged and chaperoned by company executives -- which demonstrated such exciting entrepreneurial acumen and spirit.

Plus, it was happening in China, the greatest investment opportunity of all time -- which seemed to be the beginning and the end of most China-stock investment theses.

Wellington Management, which oversees more than $600 billion in assets around the globe, acquires 8% of a Shanghai maker of yogurt cultures named China-Biotics (CHBT).

The hedge fund Paulson & Co., run by John Paulson, the legend who called the mortgage crisis, goes long the Toronto-listed shares of a grower of Chinese trees.

The investment vehicle of famed former AIG (AIG) boss Maurice "Hank" Greenberg cuts a deal to buy 15% of a firm with a can't-miss business model -- install flat-screen TVs on inter-city buses and sell advertising on those screens -- named China MediaExpress (CCME).

The gurus at private-equity behemoth Carlyle can't resist taking a more than 20% stake in a company that says it produces organic fertilizers and that has a director with a faked resume. The company also was brought public in the U.S. with the help of a stock promoter with a colorful regulatory history.

All of those investments have ended in disaster. Auditors have resigned, alleging fraud. Regulators have launched investigations, suspecting fraud. Exchanges have banished equities, fearful that fraud is ongoing.

These financial disasters will affect the big fund managers only minimally, of course; they'll remain rich. (For most of these firms, their China-stock holdings, even at the top of the market last fall, weren't substantial enough to amount to a rounding error on the value of their largest single positions.)

But for many small retail investors who followed that smart money into these stocks, lulled by the highly flawed logic that sophisticated market players "must have done their due diligence," financial ruin has come.

Here's a list of some top money managers (in no particular order) who have led retail investors down these dubious paths:

(None of the funds described below would comment on their China investments for this story, let alone offer a description of what due diligence measures they take before investing in foreign-based equities.)

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