New-model China tempts investors to test the water

With a buoyant domestic market, the People's Republic is in phase II of its economic revolution

You may well never have heard of China Mengniu.

The milk producer - the name translates as "Mongolian cow" - has captured nearly a third of the domestic market and is expanding at a rapid rate.

It's not the only cash cow in China, for the emergence of successful home-grown brands shows how the national economy is becoming more balanced and no longer so reliant on the export of cheap goods.

And that - for UK inves- tors yet to tap into their annual tax-free £7,000 individual savings account (ISA) allowance - could make the country a better bet for high-risk investment.

"The rise of the healthy Chinese company selling into its own market and able to make profits could change the fortunes of investors in China," says James Calder, head of research at fund manager Berry Asset Management.

Martin Lau, who runs the First State Greater China Growth fund, is using investors' cash to pick enterprises that benefit from the burgeoning spending power of the Chinese consumer. "I've avoided those companies, producing items like cheap televisions and computers, that have seen their profit margins slashed as more suppliers move into the same area," he says.

While China is often in the headlines for controversial reasons - from its preparations for the 2008 Olympics to its occupation of Tibet - investors are focused on a different story: the potential for big returns.

If you had put £1,000 in the First State Greater China Growth fund 12 months ago, you would have £1,319 today, reports Trustnet, the fund researcher and analyst. Compare this with £1,000 invested in the average-performing unit trust in the UK All Companies sector - today, worth £1,219.

The swelling ranks of the Chinese middle-classes have stoked a consumer boom, and Philip Ehrmann, manager of the Jupiter China fund launched three weeks ago, believes the annual growth of 8 to 10 per cent recorded for the past six years can continue. "History has shown that when an economy takes off, it can expand rapidly for 10 years or more," he says.

But in choosing the 40-odd companies making up his portfolio, he is keen to avoid the manufacturers that drove the early stages of China's development. "We are now entering the second phase," he says, "where tremendous growth in the number of middle-income families is resulting in the emergence of domestic demand. This is crucial as it reduces the country's reliance on global markets."

Until recently, a big disincentive for investors was China's flagging stock market. The Shanghai exchange has consistently failed to meet expectations, chiefly because of a lack of high-performing companies. But recent reforms by the Chinese government have propelled more businesses on to the index and opened them to foreign investors.

Despite all the buoyancy, there are warning signs too. Interest rates have been raised twice this year and many investors are concerned that the economic expansion cannot continue at such a runaway rate.

Given that returns are likely to be volatile, anyone considering heading east with part of their ISA fund needs to be cautious.

"Chinese equities are only something to which the more adventurous might allocate around 5 per cent of their portfolio," says Tim Cockerill, head of research at independent financial adviser Rowan & Co Capital Management. And even then they should only do this if they are "convinced the country's stock market is about to do well".

To dilute the risk, you could try a broader Asian or "emerging markets" fund that includes China. Mr Calder recommends the Invesco Perpetual Asian fund.

Tim Sharp is a writer for 'New Model Adviser'