Alarm bells are going off in the Chinese mutual fund industry, which posted a collective $489 million net loss in the second half of 2004, Reuters reports. China's nine-month stock slump, fierce competition and a lack of derivatives to hedge investments contributed to a gloomy outlook for two-thirds of the country's 153 mutual funds.

With investment giants like Merrill Lynch & Co. pouring money into the Chinese economy, which grew by 9.5% last year, the country's $40 billion mutual funds sector has been registering double-digit growth rates in the past few years as Chinese seek higher returns on increasing income.

However, analysts now speculate that the scarcity of investment choices, notably among them a lack of hedging tools, may leave the sector vulnerable to volatile stock markets. In spite of few investment options, Chinese investors with $1.52 trillion in savings have ramped up demand for investment products, pushing valuations to 25 times earnings on average and making stocks nearly twice as expensive as in Hong Kong. Worse, only a third of the market is traded, with the rest lying in non-traded, government-owned shares.

Among the winners, Beijing-based China Asset Management Co. Ltd., Shenzhen-based China Southern and Boshi Fund management companies reaped the highest profits in 2004. Foreign-invested funds, which generally yield higher returns, were not among the top performers last year.

With China's benchmark index falling more than 3.5% this year and investor confidence plunging, funds may have a tough time staying afloat as non-traditional competitors such as insurers and banks enter the market.

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