Trading on the Hong Kong Stock Exchange is expected to remain volatile in the run up to the Chinese New Near in early February as investors push and pull over issues concerning the US economic and its impact on Asia, interest rates, and oil prices. But many fund managers with exposure to Asia are sticking to their overweight bet in Hong Kong equities, which they expect to outperform others in this region over the next 12 months.

Hong KongÆs Hang Seng Index ended 2007 at 27,812.65, up 39% for the year. That marked the benchmark indexÆs best yearly gain since 1999, but it was nevertheless way below a record high of 31,958 in October. In the first three trading days of 2008, the index shed 1% of its value.

Fund managers believe Hong Kong will be among the interest rate sensitive markets that will benefit from a continued monetary easing policy in the US. The US Federal Reserve is under pressure to help keep interest rates low and cushion the impact of a slowdown in the US economy. The FedÆs key federal funds target rate was last cut by 50 basis points to 4.25% in December, and more cuts are expected this year.

ôHong Kong benefits from a strong liquidity impetus, thanks to the Hong Kong dollar peg,ö says Tahnoon Pasha, head of equity investments for Asia at Manulife Financial in Hong Kong. ôWe also expect to see returning asset price inflation, thanks to capital flows from the mainland.ö

Pasha favours property companies and banks in Hong Kong, which will benefit the most from a low interest rate environment.

Alistair Thompson, deputy head for Asia ex-Japan equities at First State Investments, includes the interest rate-sensitive companies of Swire Pacific, Hang Lung Group and Cheung Kong among his top picks in Hong Kong.

The future of China shares appears shaky, with fund managers increasingly turning to an underweight or neutral position in that market after being overweight for many months. Valuations have been a foremost concern lately, as well as the rehashed worries over a possible overheating of the economy.

ChinaÆs Shanghai Composite Index, which tracks both A and B shares, posted a stellar 97% gain in 2007, ending at 5261.56, making it the world's best-performing major stock index last year. The smaller Shenzhen Composite Index ended last year up 163% at 1447.02.

Hugh Young, managing director at Aberdeen Asset Management Asia, notes that valuations of China shares are trading at a substantial premium to the rest of the region and do not reflect fundamentals.

ôSpeculation is rife, with the market capitalisation of several leading companies now exceeding that of their long-established developed world counterparts. For that reason alone, we could see the market fall sharply,ö Young says.

In a Merrill Lynch fund managersÆ survey last month, the respondents said they were going most overweight in Hong Kong this year within the Asia-Pacific region, with Taiwan a distant second and Singapore third. A net 32% of the respondents said they were planning to be overweight in Hong Kong, sharply higher than the net 15% who said the same thing the previous month. Merrill Lynch takes the net positions of fund managers in each survey question by measuring positive responses against negative responses.

The fund managers surveyed were planning to be underweight in the rest of the Asia-Pacific markets, especially China. A net 16% of the respondents said they were planning to be underweight in China, sharply higher than the net 1% who said the same thing the previous month.

Fund managers looking for alternatives to Hong Kong and China, meanwhile, are looking at opportunities in Southeast Asia, a market where many expect to see surprises on the upside this year.

ôWe favour the Southeast Asian markets as they have been the laggards in 2007,ö says Husan Pai, investment director for equities at Halbis, the investment specialist of HSBC Group.