Hong KongÆs stock market has enjoyed a massive boost thanks to ChinaÆs qualified domestic institutional investor (QDII) program. The three latest QDII mutual funds launched in the mainland have been granted quotas totaling $13 billion (and raised far in excess of that from eager subscribers), with many more launches expected. Approximately 40-50% of these assets are expected to go directly into Hong Kong stocks, and investors in Hong Kong and worldwide have poured into the market in expectation of this injection of mainland liquidity.

The QDII regime also includes bank products for mainland depositors, which also contribute to the asset flow into Hong Kong. Mainland insurance companies have yet to have their QDII rules finalised, while trust companies and brokerages are developing QDII products.

But mutual funds have proven the most spectacular vehicles for QDII, thanks in part to the expansion of the domestic industry. ChinaÆs domestic mutual funds recently passed the RMB3 trillion mark ($400 billion) of total assets under management û a four-fold increase in merely 12 months, according to figures released by Z-Ben Advisors, a Shanghai research company.

This expansion reflects the massive run-up in the domestic A-share stock markets, which is making regulators nervous. Last month, the massive expansion prompted the China Securities Regulatory Commission (CSRC) to stop issuing new approvals for mutual funds invested in A shares.

Zhou Liang, head of research at Lipper in Shanghai, says the regulatorÆs intention is very clear. Excess liquidity trapped in China must be let out before new issues of Chinese A-share funds will be approved, which means Chinese investorsÆ key focus will be predominantly shifted to overseas investment products, namely QDII products.

To date, four fund houses have issued QDII mutual funds: Huaan Fund Management (with Lehman Brothers), China Southern Asset Management (with Mellon), China Asset Management (T. Rowe Price) and Harvest Fund Management (in which Deutsche Asset Management holds a minority stake).

The Huaan fund, introduced on a pilot basis in 2006, had a quota of $500 million but is widely considered a failure, in part because it delivered low returns and came with high fees. But in September, China Southern introduced a more aggressive, more attractively structured QDII fund that proved a huge success. Since then other launches have been in the China Southern mould, with an emphasis on arbitraging the mainland and Hong Kong markets.

Z-Ben says the amount raised by recent launches has beaten analystsÆ most optimistic projections. The two funds launched by China Southern and China AMC have totaled RMB111 billion ($14.8 billon). HarvestÆs maiden launch on Monday has brought in another RMB70 billion ($9.3 billion) in just one day. It was 19 times over-subscribed as its overseas investment limit is capped at $5 billion.

Demand has once again prompted the central bankÆs forex arm, the State Administration for Foreign Exchange, to raise QDII fund quotas. China SouthernÆs original quota of $2 billion was bumped up to $4 billion; now Harvest has been allowed to keep $5 billion.

Hong KongÆs stock market has seen approximately $24.8 billion liquidity injected, from August 17Æs latest trough at HK$898 billion ($115.7 billion), to HK$1.09 trillion ($140.5 billion) yesterday. QDII funds have propelled the Hang Seng Index on a wild one-way ride since its nose dip from subprime crisis at 20,387.13 to yesterdayÆs 28,228 level. These QDII funds allocate 40-50% of the portfolio into Hong Kong-listed Chinese companies, playing the arbitrage against higher valuations for A shares.

The wild ride ainÆt over. Three more QDII funds are slated to launch before the end of the year, including offerings from China International Fund Management (a joint venture of JPMorgan Asset Management), Fortis Haitong Investment Management and Fortune SGAM Fund Management. Analysts are now confident these funds will sweep up $4-5 billion each. This means another $12-15 billion of new global liquidity, with up to half likely dedicated to Hong Kong-listed stocks.

Z-Ben Advisors believes another 18 funds are waiting for their turn over the course of 2008 next year. A crude calculation suggests if these also raise $5 billion each, the market would see another $90 billion of overseas investments û not a wild estimate, considering fund houses can raise nearly $10 billion in a single hour.

There are 37 fund houses out of the industryÆs 58 that can meet the CSRCÆs hurldes. Subject to CSRC approval, Bank of Communications Schroders, Bosera Fund Management, E-Fund, Full Goal, Guangfa, ICBC Credit Suisse, Invesco, Lion and UBS SDIC are among those preparing QDII products.

Meanwhile more international fund managers are rumoured to be negotiating joint ventures, including AllianceBernstein, Luxembourg-based private bank Edmond de Rothschild, Royal Bank of Canada and SingaporeÆs UOB Asset Management.

Z-Ben, however, says caution should be in order. The market is tempting but foreign firms need to understand exactly what role they will be expected to play, as well as understand the time and energy required to pursue a QDII product alliance. Lastly, the industry has set itself a high benchmark. Investors expect annualised returns in excess of 100%, despite the fact that overseas assets are unlikely to match that. Should markets or sentiment sour, Z-Ben suggests the blame may be shifted to the foreign partner.