beyondbrics

Muddy Waters, the short-selling group famous for triggering the collapse in the share price of Toronto listed Chinese company, Sino-Forest, was at it again last week.

US-listed shares in the Shanghai advertising firm, Focus Media, dived last Monday following the publication of a less than flattering report by Muddy Waters, which alleged it had overstated the size of its advertising network.

The company issued a statement denying the report and perhaps independent verification of its side of the story will see Focus Media’s share price eventually recover to where it was. However, the latest incident highlights serious issues for all investors in North American-listed Chinese companies.

It would seem the lack of faith from investors might make the hundreds of small and medium-sized Chinese companies with stock market listings in North America particularly vulnerable to the rumour mill.

Even star investors are not immune. Also on Monday, Anthony Bolton, manager of Fidelity’s China Special Situations investment trust, was explaining a decline in net asset value of 28.9 per cent over the six months to the end ofSeptember and a fall in its share price of 31 per cent. He said investing in Chinese “reverse merger” stocks had been his “biggest disappointment”.

Bolton said the reverse merger stocks, Chinese companies that have gained “backdoor” listings on US exchanges through the purchase of shell companies, had “been bad” by a multiple of “two or three times” more than he had expected.

Bolton said his company now employed five firms that specialised in “this sort of due diligence” to check these companies out.

One might think that Bolton of all people would be sick of the rumour mill and would like to reassure investors by revealing the names of these firms. Instead, he seems to have caught the opacity bug and is not willing to disclose anything about them. (Investors might, at the very least, be interested to know how much they cost).

A spokesperson from Fidelity said the firms could not be named “as they are commercial relationships and are confidential”.

“I would point out that the depth of our research means that we always try to get a 360 degree view of the companies we invest in, wherever they are based. This includes talking to investors and suppliers and, if necessary, doing further due diligence. This is something we have always done in order to get a full picture,” the spokesperson added.

So the message appears to be: you can trust us with your money, but we can’t reveal exactly what makes us so trustworthy – not terrifically reassuring.

With so little to go on about these US-listed Chinese stocks you can see why there is such huge interest in anybody who sounds as though they know what they’re talking about.

Which leads us back to Muddy Waters. Incredibly, Muddy Waters warns investors that it takes trading positions in the companies ahead of the publication of its research, and may later buy or sell securities that are the subject of its research.

Ordinarily, the fact that Muddy Waters’ position is so blatantly partisan would have investors reaching for a grain of salt as they were reading its report. Instead, they are rushing to sell.