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WALL STREET, CALIFORNIA | MANAGER'S FORUM

Riding on a Dragon's Back

Plenty of Reasons for High Expectations, This Pro Says

June 10, 1997

In less than three weeks, China will regain control of Hong Kong, including its vibrant financial center. The transfer is raising anxiety levels worldwide, but many investment pros expect continued prosperity for Hong Kong.

Richard Farrell is among the optimists. He manages the Guinness Flight China & Hong Kong stock mutual fund. In its two years in existence, the fund has had the best showing of any Pacific-region stock fund, according to Lipper Analytical Services.

The fund gained 49% in the two years ended March 31 and has surged an additional 17% since then, propelled by a powerful rally in Hong Kong stocks.

Farrell, 54, oversees half a dozen Asian mutual funds, some for U.S. investors, some for non-Americans. All told, they count about $700 million in assets, with Guinness Flight China & Hong Kong holding nearly half.

Farrell oversees a staff of Asia-based analysts from his office in London. Much of his free time is spent in local politics: He's a district counselor representing a couple of villages south of Oxford, England, for the Liberal Democrat party. He was interviewed by Russ Wiles, a mutual funds columnist for The Times.

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Times: Given the fresh surge in the Hong Kong stock market this year, it's safe to say that investors overall are bullish about the transfer of Hong Kong to China. Do you feel this optimism is warranted?

Farrell: Very much so. To be realistic, some human rights are going to be eroded in Hong Kong. There will be changes. But there are many reasons why China wants to see the whole process work smoothly. Most important, there's the question of face. If Hong Kong doesn't fare as well under the Chinese as it has under the British, there would be a tremendous loss of face for the Chinese.

Besides, the Chinese really don't have any alternative but to embrace open markets and international investors in order to provide real jobs in their economy, to make up for those in the old state-owned smokestack industries. Also, in the long term China faces a rising food-import bill, for which they need to generate foreign revenues.

Then there's Taiwan, which they definitely want to bring back into the fold. The only way they realistically could do this--without taking over the ruins of Taiwan--would be to show that one country with two systems really can work.

Times: Some observers have described Taiwan as ultimately a more significant prize than Hong Kong. Do you agree?

Farrell: Yes, in strategic terms. Quite frankly, the Chinese could have had Hong Kong back any time they wanted over the past 40 years. Hong Kong is indefensible.

Taiwan is an entirely different situation. Getting it back requires much more subtlety and thus certainly would be a bigger prize. But economically, I actually think that the combination of Hong Kong and Guangdong province is potentially the jewel of the crown of Asia. This region has a critical mass, in area and population, of a country the size of France.

Times: What do Hong Kong and China each bring to the marriage?

Farrell: Hong Kong brings two important things. First, its entrepreneurs have been acting for some time as the managing agents for manufacturing in southern China. These entrepreneurs largely have been responsible for setting up light electronics manufacturing, selling the products in Europe and overseeing the management process.

Also, Hong Kong has an absolutely thriving financial market. China requires a marketplace to raise the significant amounts of capital that it needs to continue developing its own industry and infrastructure. Hong Kong has the world's sixth-largest stock market. It's very well-organized and sophisticated. And following some scandals back in 1987, it has been well-policed.

China offers a slightly more mixed bag. Most significant, [unification] opens up to a greater extent to Hong Kong a market of 1.2 billion people, with all the long-term potential that comes with that. China also provides Hong Kong's food and water, which is not insignificant.

Times: Which stock market regulations will be used after July?

Farrell: I hope it will be more a case of China moving to Hong Kong's standards. China's embryonic market [in the past] rested on an uncertain accounting and legal structure.

The Chinese now are on a steep and rapid learning curve, which they're going up impressively in terms of laying an accounting and legal foundation. They also are coming to realize that they must manage shareholder relations. It's not just a question of taking money from shareholders and forgetting about them, as happened in the past.

Times: You mentioned Hong Kong's entrepreneurs as an important factor. Is there a danger that they will flee after the transfer of Hong Kong to China?

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