With a gain of more than 70% from its November lows, the Hong Kong market has now almost returned to early 2007 levels and investor risk appetite is normalising, albeit at a slow pace, Schroder Investment Management notes in a recent report. From here on, the fund house advises investors to proceed with caution.

"The very conservative positioning has left many investors behind, and a more recent scramble to catch-up has provided further fuel to the equity rally," Schroders says. "However, with the continued uncertainty about the outlook for the global economy in the next few quarters, we would be more cautious about near-term prospects."

Hong Kong share prices are now much closer to Schroders' bottom-up fair valuations, with fewer discounted valuations on offer than two months ago (2009 P/E ratio now at 17 times, versus 16 times in 2008, in line with long-range average), and domestic blue-chip stocks are back within 15% of pre-bubble levels. However, in terms of price-to-book ratios, the market is at 1.4 times which is still a 20% discount to the long-range average.

Schroders notes that Hong Kong's property market reacted quickly to rising equity markets, with the gloom of late 2008 being replaced by optimism. Recent evidence shows a pick-up in secondary transaction volume and prices, and affordability is good with very low interest rates and more Hong Kong Interbank Offer Rate (Hibor)-linked mortgages. Prices may recoup the fall in 2008, the fund house says, but rising unemployment and uncertainty over the economic outlook represent potential headwinds on the upside.

Office rents are also beginning to show some signs of easing on the back of weaker demand, after rising 15% in the first half of 2008. Schroders continues to believe that the downside in this cycle will be more muted than in past episodes. Vacancy rates in Central grade-A offices are still very low at less than 5%, and new supply has been negligible for many years with no disruptive pricing evident.

In terms of Hong Kong property and conglomerate plays, Schroders sees them approaching fair value, with developers and investors moving up sharply from depressed valuations, and discounts to net asset values (NAV) close to their long-range averages. The fund house continues to favour local asset plays, particularly those with strong balance sheets and sound management teams, given the ultra-low interest rate environment and the lack of supply in Hong Kong.

Recent portfolio moves at Schroders have been to take profit and recycle cash into more defensive stocks, having been fully invested in the market lows.

Schroders remains overweight on property, select financials, industrials and conglomerates, consumer goods and services, and energy. The fund house is underweight select financials, technology, telecoms, and utilities.