China's house of cards?

Bears say China's economy is due for a crash. But bulls say its growth potential can't be ignored

By Jan Alexander

China appears to have two economies: one that is a huge bubble of misallocated capital and one that just keeps growing. The first is most famously the view of Jim Chanos, president of Kynikos Associates in New York, who in recent months raised $20 million for a new offshore hedge fund that is expected to hedge against Chinese property. Chanos has argued that rampant real estate speculation has made China look like "Dubai times 1,000--or worse."

On the other hand, Aaron Boesky, the chief executive of Hong Kong hedge fund Marco Polo Pure Asset Management, looks at China and sees almost limitless growth over the next decade or so. Boesky agrees that the real estate market is overheated, but he thinks that rather than pulling money out of China, investors should look to the stock market.

It's been a bumpy ride so far--China's A-share index hit a high of 6,470 in September 2007, bottomed out in 2008 and has yet to recover. It is now limping along in the 3,000 range, but Boesky thinks the index will rise to about 10,000 by 2015, thanks largely to the buying habits of the investor base and the signs of deflation in the real estate bubble.

"Some 99.5% of the A-share market is owned by domestic investors, and they're a very homogeneous group," says Boesky, whose flagship Marco Polo Pure China Fund operates with size restrictions as a Qualified Foreign Institutional Investor (which allows a certain amount of trading in domestic securities) in A shares.

The fund manages about $100 million. So far this year, it is down 8.33% through April and has delivered an annualized return of 17.89% since its launch in September 2004.

"Traditionally in China, when you're worried about the market you buy real estate, something you can own and touch," says Boesky. "Chinese investors are now looking around and seeing all kinds of policies to crack down on real estate investment, while stock markets around the world are coming back, so they'll start putting their money back into the stock market." Boesky's fund has taken short positions in property-related stocks.

Hedge fund...