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For Funds, China May Be the Last Big Recovery Play in Asia

Perhaps most reassuring about China is that managers seem to be finding fast-growing, cheap-looking companies.
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Buying into Asian markets that had been given up for dead has been one of the great trades of the past year -- and fund investors have been quick to exploit it.

And with funds focused on such places as Korea and Hong Kong already showing prodigious returns, funds investing in mainland China may be one of the last big recovery plays left in the region.

During the dramatic climb back in Asia, single-country investment vehicles have provided some of the best returns. For example, the

Matthews International

(MAKOX) - Get Matthews Korea Fund Investor Class Report

Korea fund has returned 103% over the past 12 months, according to



Malaysian WEBS

(EWM) - Get iShares MSCI Malaysia ETF Report

, country-basket securities listed on the

American Stock Exchange

, have rocketed 95% since the beginning of the year, while the

New York Stock Exchange


Indonesia Fund

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, a closed-end fund, is ahead 66% over the same period.

Investors thinking of getting into mainland China have two mutual funds to choose from: the $2.1 million Matthews


and the $8.9 million

Guinness Flight


Mainland China.

Over the past month, mainland Chinese stocks have really gotten hot. The

MSCI China Free Index

climbed 25% in April, almost double the return for the Asian region as a whole. In the same month, the two China funds returned quite a bit less: Dragon added 17.4% and Mainland China 14.3%, according to Lipper.

Even after last month's solid gains, the funds' longer-term returns bear witness to the severity of the rout in Chinese stocks. Over the 12 months through April 29, Dragon,

launched last year, is down 32.7%, while Mainland is off 26.3%. The two funds are by far the worst-performing in Lipper's 17-strong China region category, which is dominated by funds that invest mainly in Hong Kong blue-chips and Taiwanese stocks, as opposed to companies based in or focused on mainland China.

Anyone hoping for rapid mega-returns ought to note that, while China managers are optimistic, they are also guarded. Adrian Fu, a Hong Kong-based manager of Mainland, expects his top 15 holdings to return more than 25% over the next 12 months. But he stresses: "A sustained rally requires a turnaround in China's exports or consumption."

Dragon manager Mark Headley is also a little cautious about the recent run-up: "I have yet to see a broad bullish sentiment develop." He reckons, however, that Chinese stocks will easily outperform other Asian markets over the longer term if reformers like

Premier Zhu Rongji

are able to press on with their liberalizations.

China also is attracting money from some managers of global emerging-markets funds, who, unlike Fu or Headley, have the option of avoiding the country. "We've seen the worst for the economy. The slowdown is playing itself out," says Travis Selmier, manager of


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Emerging Markets, which has lost 15.6% over the past year, ranking it 70 out of 173 other emerging-market funds. Selmier has nearly 8% of his fund in Chinese stocks, way above the roughly 2% weighting the country has in global emerging-markets indices.

Economics and politics will play a huge part in determining the fate of Chinese stocks. A possible

devaluation of the yuan scares some. But Fu rules it out for 1999 because trade performance is, in his view, improving. Headley says devaluation won't happen while the government is trying to reform the banking sector. Selmier actually expects (but wouldn't worry about) a controlled 10% to 15% devaluation. "There's a high probability it'll happen later this year when there's a pickup in the global economy," he says.

Any sign that

Communist Party

hardliners are stymieing Zhu's market-based reforms, or even plotting his removal, would send Chinese stocks reeling. With the 10th anniversary of the Tiananmen Square massacre June 4, tensions between Zhu and the old-style


may increase if he shows reluctance to clamp down on any possible demonstrations. Fu's not fazed, though: "We do not expect political unrest during the Tiananmen anniversary."

Perhaps most reassuring about China is that managers seem to be finding fast-growing, cheap-looking companies. For example, Fu likes toll-road company

Zhejiang Expressway

. The company is trading at around 10 times forecast 1999 earnings and could post a 40% increase in earnings per share this year. Headley likes

Guangdong Kelon

, a refrigerator maker, which is trading at about nine times 1999 forecast earnings, which are expected to grow 13% this year.