Many Chinese companies are moving to the private sector as part of the opening of the country's economy. An increasing number are choosing to list on the Hong Kong stock exchange to attract foreign investors. However, results have been mixed and fund managers tell investors to proceed with caution.
The boom in China's economy was clearly demonstrated in June when three Chinese companies launched the biggest initial public offerings of the year on the Hong Kong stock exchange.
Shenhua Energy, Bank of Communications and shipping company China Cosco Holdings together generated $6 billion in share sales - a record for a single month on the exchange.
Another wave of share offerings from Chinese companies is expected later in the year. Hugh Young, managing director for Singapore-based Aberdeen Asset Management, says Hong Kong listings are part of the move by China's state-owned companies into the private sector. "China is using the capital markets to raise substantial amounts of money for its various businesses, virtually all of which had been in the state sector. So they are raising capital, attracting investors and, in certain cases, major institutions, whether banks such as HSBC, as core investors and the like; all part of the opening up and development of China," he says.
One reason some Chinese companies choose to list in Hong Kong and on foreign exchanges is the poor reputation of the smaller Shanghai and Shenzhen stock exchanges.
Fund managers say many of the companies listed on the mainland Chinese bourses lack skilled management and have little experience in creating shareholder value.
Some, like Hong Kong-based Standard Life Investment fund manager Agnes Deng, see a Hong Kong listing as beneficial for both capital hungry corporations and investors eager to profit from China's economic growth. "It's kind of a win-win situation. In terms of the investor, definitely, it really provides more and more for the investor who wants to get exposure to the China growth. It also benefits the Chinese companies which can actually go outside and access the international capital markets," she says.
However, investing in China includes some extra risk. Although the government has urged companies to strengthen management and clean up corruption, China's major industries still suffer from considerable instability.
Mr. Young says there is often a disparity between investors' visions of business in China and actual results. "It's a very easy marketing story. So you can easily imagine board members in U.S. and Europe saying, 'Yes, we need to establish operations in China and, yes, we are willing to spend a few hundred million dollars to get a foothold.' The actually reality of doing business in China is a lot more difficult and making money is not so terribly easy," he says.
China's biggest coal producer, Shenhua Energy, did not perform well on its first day of trading in Hong Kong, falling nearly three percent below its initial price. And Cosco Holdings slipped 10 percent below its initial asking price, due to a weak outlook for global shipping.
Historically, China stocks have not made a great deal of money, and many have fallen off the radar screen since going public. China Mobile and footwear manufacturer Yue Yuen Industrial are among recent top performers.
Louisa Lo, a fund manager for Schroder Investment Management, says oil and telecom stocks typically provide steady returns on investment, but businesses in other sectors fall victim to market swings. "The problem with a lot of China stocks, they actually move - the share price move - in tandem with the [business] cycle. The steel ones go up and down like a yo-yo. So that actually makes the index itself very volatile and the share price very volatile," she says.
Perhaps the best example of the combination of potential and risk for investment in China is its banking industry.
The banks are among China's most vulnerable businesses because they hold vast amounts of bad loans, but they have generated the greatest interest from investors because of their potential for improvement.
Bank of Communications jumped more than 12 percent on its first day of trading, after initially raising almost $2 billion. And financial analysts expect strong debuts later this year from both China Construction Bank, in which Bank of America recently took a nine percent stake, and China Minsheng Banking Corporation.
Howard Gorges, vice chairman of Hong Kong's South China Brokerage, says the Chinese government has been taking aggressive steps to improve the banks' business practices. "The banking system in China has been a basket case and the state's been bailing it out and trying to put more discipline on the banks, and it has allowed foreign banks to become shareholders to bring in modern methods of management and risk control. So they clearly want to make their companies and banks competitive and up-to-date," he says.
Chinese companies are lining up to go public in Hong Kong - about 13 more are expected to list before the end of the year.
But analysts say they should be careful not to flood the market and risk wearing out investor interest, especially as some share prices remain below a dollar.
Also, investors should bear in mind that China's economy, like those of its Asian neighbors, is vulnerable to the high price of oil and other natural resources.