Why you should avoid investing in China for now

Anthony Bolton must sometimes rue the day he agreed to come out of retirement and run a China fund. The share price of his Fidelity China Special Situations trust fell 31.2% in the six months to the end of September. Worse, he seems at a loss to explain it other than to say that "performance has been very disappointing". For investors thinking of investing in China, that's hardly reassuring. Our advice? Don't.

Yes, over the longer run it will be hard to ignore an economy tipped to overtake the world's number one, America. But good investing isn't just about spotting opportunities, it's also about getting your timing right. Just now, "near-term profitability is shrinking and prospects for 2012 look dismal", says Rita Raagas de Ramos in the Financial Times. As Boston-based consulting firm Cerulli Associates explains, the fund management industry in particular is braced for an "immaculate storm".

Assets under management are shrinking, distribution costs are rising and new competitors have been flooding into the market. They couldn't have chosen a worse time, given the CSI 300 Index, which lists 300 A-shares in Shanghai and Shenzen, is down 15% so far this year and 23% over the last 24 months. In short, China currently presents "numerous risks to foreign fund management firms".

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As for individual stocks, Sam Subramanian on Marketwatch.com points out why returns have generally been so poor despite the 316% growth in China's economy over the last decade. For a start, Chinese firms have regularly overestimated the profit growth they could deliver. This has been compounded by poor corporate governance and accounting (something Bolton has also acknowledged).

More recently, the big problem has been inflation. China's central bank has been raising rates to try to combat rising prices, but that has made it hard for companies to get loans anecdotal evidence suggests that even the unofficial grey market for loans is drying up. And just for good measure, China's exports to Europe are now being hammered by the eurozone crisis. These issues may not result in a 2008-style crash for China, but they will take time to resolve. So regardless of how bullish you are on China's long-term outlook, we'd be wary of piling in now.