NEW YORK - Overseas Mutual fund managers have had a good run with Chinese stocks, but some are now backing off, saying China's market is a bubble that will burst sooner rather than later.

The Chinese market appears to be in the "later, waning stages of a bubble," said Justin Leverenz, manager of the nearly $13.5 billion Oppenheimer Developing Markets Fund. The fund is now "extraordinarily lean" in exposure to Chinese stocks, he said.

Leverenz, who looks to double his investment over a three-year, four-year or five-year time period, said he expects that "a significant contraction" in the valuation of Chinese equities will play out much more rapidly than that. He noted that China's domestic A shares have risen nearly 500 percent over the last two years. "2008 will be an incredibly difficult year for Chinese equities."

Other fund managers agree and are pulling money out of Chinese shares, though a few said they're still finding buys in select H shares, those of mainland-registered companies listed on Hong Kong's stock exchange.

Antoine van Agtmael, chief investment officer of Emerging Markets Management, who is credited with coining the term "emerging markets" in 1981, said China's booming economic story is real, but its stock markets have been bought up in a mania.

Van Agtmael said he reduced his investments in China quite a while ago, likely a mistake because it was too early. Though he still believes China's story is a good one, he said, "I don't trust this phenomenal rise in the A share market and now the H share market at all."

Both markets are in a bubble, and "like all bubbles, it will end in tears," said van Agtmael. "I believe this is going to be sooner rather than later."

Uri Landesman of ING Investment Management agreed that China is a great long-term story, but said "it's a great long-term story with a lot of volatility."

One sign of the froth: six of the 10 top-performing mutual funds this year through November 30 have China in their names, according to Morningstar. Among them are AIM China A, which has a total return of 86.12 percent in the period; Nationwide China Opportunities A, which has gained 83.43 percent in the period; and Matthews China, which has gained 75.83 percent, according to Morningstar.

But the mania appears to be waning. Brad Durham, managing director at Boston-based fund tracker EPFR Global, said that inflows to dedicated China funds and Greater China funds, which can invest in the Chinese mainland, Hong Kong and Taiwan companies that are doing most of their business in the mainland, have not been as excessive as they were last year.

The China-dedicated equity funds that the firm tracks - which don't include the domestic mutual funds in China open only to Chinese investors - had outflows of $3.43 billion this year through November 28, while Greater China funds had inflows of $2.95 billion in the period, Durham said. The Greater China funds are a bit more diversified, which likely makes investors more comfortable, he said.

Van Agtmael said there are fundamental concerns. China's economic growth, which had been about 8 percent to 10 percent on average for the last 20 years, is now above 11 percent, an unsustainable level, he said.

Inflationary pressures are being seen, he said, noting that consumer prices rose more than 6 percent in August and September. "Inflation will continue to be higher than people expect so that the Central Bank will at some point be forced to act a little more forcefully than they have this far when they've acted rather feebly," he said.

The so-called "through train" plan was announced by the State Administration of Foreign Exchange (SAFE) in August, enabling individual mainlanders to invest in Hong Kong shares. That plan has been delayed. It's part of the reason the H share market rose so much, said van Agtmael, but its impact is likely to be disappointing.

Some expected that Chinese retail investors "could now invest more or less in an unlimited fashion in Hong Kong," and expected that that would present an arbitrage opportunity, he said. "I don't believe that ever was the intention; the intention is to take a little pressure of the A share market in a controlled way."

Leverenz noted that there's a huge amount of excess savings trapped onshore in China and insufficient assets to absorb it. More than US$2 trillion is sitting in bank balances in China earning negative real interest rates, he said. As a result, money has piled into risky assets, and prices are extraordinary, he said.
For a number of reasons, this bubble will pop reasonably soon, he said. With the rest of the world slowing, China is going to face a situation where the external environment isn't good, he said.

Landesman of ING said that while a US or global slowdown will have less of an impact on China's economy now than it would have in the last cycle, it will still have an impact.

"If there's a global economic slowdown, it's not good for anybody," he said.

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