Martin Currie Investment Management, the Edinburgh-based fund manager, is negotiating the relaunch of its $38 million China Heartland Fund. The fund has been suspended since May 2001 because of foreign exchange regulation problems, leaving its mainly specialist institutional investors unable to redeem their shares.
The China Heartland Fund, launched in June 1997, claims to be the only offshore fund that gives foreigners access to China’s domestic A-share market. A shares – red-chip stocks – are issued by mainland companies in which investment is restricted to Chinese citizens. The highly liquid and speculative market suffered big falls in 2001, forcing the government to postpone the planned sell-down of its holdings, about 50% of most major listed companies, for fear of worsening the situation.
Despite this, and the possible loosening of restrictions on investing in Hong Kong-listed stocks by mainland funds, some foreign investors are still optimistic about the market. “The economy is still growing rapidly compared with others, and exports are very competitive”, says Chris Ruffle, the fund’s manager. Over the past year the A share portfolio has outperformed the Shanghai Composite Index by 6.5%.
Martin Currie’s Bermuda-listed fund enabled indirect foreign investor exposure to the A-share market through a joint venture arrangement with Shanghai brokerage China Securities Corporation. In the arrangement, Currie pays investors in the fund returns equal to the returns of the A shares in the portfolio, which its local partner purchases.
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The fund ran into problems when the State Administration of Foreign Exchange (Safe) indicated to China Securities that it might no longer be able to convert the renminbi proceeds into US dollars. This meant that the local partner could no longer meet its service charge payments to the fund.
One experienced Asian-market investor says: “Sometimes, when the law neither explicitly forbids nor authorizes something, all it takes is for someone to issue a small note of clarification and you’re shut out. It’s one of those things that only work if you’re small and keep it quiet.” The investor illustrates his point with the late 1980s’ situation in Korea. “When foreigners weren’t allowed to own Korean stocks, they tried to slip in and gain access through convertibles. But the government then decided that the bonds would not be able to convert.”
Martin Currie rejects the notion that it has been bending the rules and hopes to re-launch its fund as an exclusively A-share portfolio. It hopes to do this by reconstructing its agreement with China Securities into a swap arrangement that will allow it to continue offering foreigners A-share exposure.
Under the proposed alternative arrangement, foreign investors will only be able to realize the cash value of their investment when the A-share market is opened up to foreign investors, something that the Chinese authorities are expected to do. Despite the risks of the proposed new structure, Martin Currie expect that the fund’s investors will continue to invest in the reconstituted portfolio. They also expect increased interest from life insurers investing their renminbi in A-share funds. “We have an educational element to offer” says Ruffle, referring to his firm’s knowledge of the market.
The success of the restructuring. however, depends on approval by Safe and the China Securities Regulatory Commission. The CSRC seems favourable but Safe is being reorganized, and agreement is uncertain.
Omar Negyal, a fund manager with Foreign&Colonial in London, says the opening of the A-share market to foreign investors is a long-term goal. “There is no formal process or timetable, and no-one yet knows how they will choose to do it. It’s unlikely the government will throw open the doors completely and most expect something more similar to the Taiwanese system of allowing a select few “qualified foreign investors”.
