Warming to the dragon's mighty fire

It looked like the handover in reverse. Last month thousands in Hong Kong queued up to buy shares in Beijing Enterprises, whose franchises range from tickets for the Great Wall of China to McDonald's outlets.

The company received orders for 1,276 times the number of shares on offer in its debut. On its first day of trading, the stock tripled. The clamour to buy Beijing Enterprises is the most extreme example of the Hong Kong fashion for red chips.

This category of company barely existed 10 years ago. But at the end of last year the red chips were capitalised at HK$254bn (pounds 19.7bn), according to Nigel Chan and Annabel Betz of ING Barings Hong Kong team.

From 1993 to 1996 shares in the red chip index were up nearly 45 per cent a year - outpacing the 37 per cent average annual rise in the benchmark Hang Seng index of more conventional Hong Kong stocks.

As the handover grew nearer so did the explosive outperformance. "As the red flag goes up, the red chips go up," said John Mulcahy, managing director at Indosuez WI Carr in Hong Kong.

In the last six months the 41-stock Bloomberg Red Chip Index rose 75 per cent. The Hang Seng is up 13 per cent. On Friday the 10 most active stocks were red chips. Fuelling the rise has been investor fondness for the important ties the red chips have to Hong Kong's new rulers - they are partly owned by provincial administrations, industrial groups, even the Red Army.

Unlike mainland Chinese companies, which have listed their H shares on the Hong Kong stock market, the red chips are registered in Hong Kong. Frequently they have started life as little more than shell companies with few assets. Then they sell shares in Hong Kong and use the money to buy assets cheaply from their Chinese parents.

The rationale is that this helps the communists raise capital. "People realise Hong Kong is the gateway for China to raise money," said Stephen Ho, associate director at AIG Investment Corp Asia Ltd. Others look at the curious ways the red chips develop as quoted companies. "It's the way to privatise China," says Eddie Lau, an analyst at HG Asia.

According to Richard Farrell, who heads Asian equities at money manager Guinness Flight Hambro, plenty of Chinese money has found its way into the red chips, some of it in ways that raise eyebrows in the West.

"The terms of the asset deals have been so attractive that people in China couldn't resist," said Mr Farrell.

The authorities have also been concerned. In China companies wanting to sell assets owned for under three years to red chips now need permission from securities regulators, he said.

And Hong Kong regulators have delayed big shares sales by a subsidiary of China Everbright Holdings because it failed to provide details on its acquisition plans. Even if there is greater transparency in trading in red chips in future there is little doubt the stocks look expensive.