* China stock valuations near cheapest since at least 2004
* Stock mutual funds turning overweight on China - HSBC
* Investors see China reforms improving growth prospects
* Some still wary reforms could hurt growth in short term
By Saikat Chatterjee and Nishant Kumar
HONG KONG, April 9 China's first-ever domestic
bond defaults, a weakening currency and slowing growth are not
normal buy signals, but money managers see them as a sign that
the country's reform drive is genuine and that stocks offer
Attracted to stock valuations near their lowest in at least
a decade, investors have pushed the Shanghai Composite Index
up about 6 percent and an index of the top Chinese
listings in Hong Kong up 13 percent in a rally that
started roughly three weeks ago.
While investors are not convinced the recent bounce in
Chinese assets will blossom into a true rally, they said the
sheer scale of Beijing's financial sector reforms would be
positive in the medium and longer term.
"Things are heading very much in the right direction," said
Bill Maldonado, chief investment officer in Asia-Pacific for
HSBC Global Asset Management.
"What would you call the widening of the currency bands?
What would you call the way that that default happened? What
would you call the increase in quotas? All these things are
clear evidence of reforms," Maldonado said.
HSBC, which manages assets worth $428 billion globally, is
overweight on China in its regional portfolios.
Since unveiling an ambitious reform blueprint last October,
Beijing has embarked on reforms including overhauling its
bloated state-owned sector, widening the currency's trading band
and increasing investment quotas in a push to allow market
forces a greater say in its markets.
Those reforms have included allowing smaller companies to
default, with China recording its first domestic debt default in
This has spooked many credit investors, but money managers
said this would lay the foundation for sustainable economic
growth and possibly higher stock prices in the near term.
Funds are now raising their exposure to China even though
some investors have pulled cash from these funds over the past
few months because North Asia-focused funds have underperformed
funds invested in other regions.
A March report from HSBC said stock mutual funds had raised
their exposure to Chinese equities to near five-year highs,
significantly turning overweight on China from being underweight
three months earlier.
Another reason for this shift is that Chinese equity
valuations now look cheap after a wave of aggressive selling
early in the year. Investors pulled out about $1.8 billion from
China-focused equity and exchange-traded funds in the first
quarter, according to Lipper data as of April 3.
Andrew Swan, head of Asian equities at the world's biggest
money manager BlackRock, said the reforms added stability and
better growth prospects, and would improve the way companies are
managed in China by allowing market forces to direct credit to
the most productive sectors of the economy.
"We can't just disregard China because of the problems of
the past, because it's actually very cheap with change
happening," Swan said.
Swan manages BlackRock's $654 million Asian Dragon Fund,
39.4 percent of which is invested in Chinese- and Hong
Kong-listed companies as of the end of February.
Even after their recent bounce, Chinese equities are still
50 percent below their April 2007 peaks. By contrast, India's
markets hit a record high last week, while Indonesia is
approaching last year's peaks on reform hopes.
The IBES MSCI China Index trades at 1.33 times book value,
near its cheapest levels since Thomson Reuters Datastream began
compiling the data in 2004, and more than 77 percent below its
The index trades at 8.3 times forward 12 months earnings, 26
percent below its 10-year median. By comparison, India trades at
14.4 times, while the broader Asia-ex-Japan market is trading at
11.6 times, according to Thomson Reuters Datastream.
Money managers said that without far-reaching reforms, cheap
stock valuations would only get cheaper in the coming years as
"In the case of China what we are seeing is change starting
to actually happen. Without change, the risk is that markets and
stocks would be a value trap," Swan said.
Not all investors are so optimistic, however. Some caution
that the reforms, while necessary, would be painful and could
cause growth to slow in the short term.
These more bearish investors said they were sticking to
sectors such as property, railways and banks that would benefit
from any minor stimulus measures Beijing might launch in order
to shore up growth.
"There's no such thing as painless reform. The price you pay
is to have slower growth. That's the whole idea," Franco Ngan,
chief executive officer at Zeal Asset Management, said at the
Credit Suisse annual conference held in Hong Kong late last
month, suggesting valuations were low precisely because prices
reflected lower growth prospects.
While corporate earnings in China have surged 75 percent in
the past seven years, the MSCI China Index has plunged 40
percent, Ngan noted, reflecting the extent of negativity already
being priced into the Chinese equity market.
"I do think valuations are arguably a bit more detached than
fundamentals," said Tai Hui, chief markets strategist at JP
Morgan Asset Management in Hong Kong.
In a sign of how beaten down some of these valuations have
become, stocks from the financial and industrial sectors, often
seen as front and centre for any China-related problems, have
led the market rally in recent weeks.
(Reporting by Nishant Kumar and Saikat Chatterjee; Editing by
Nachum Kaplan and Chris Gallagher)