Like most people in finance, Karl Schamotta has heard the stories about Chinese ghost cities — vast condominium complexes built during the country's investment boom but barely lived in.

"A client who runs a large retail chain was there recently," said Schamotta, who helps corporate clients manage currency risk at Western Union Business Solutions. "One night he looked out his hotel room window and saw a landscape filled with condos but only two lights on. It was 9 at night."

For many, such anecdotes are signs China's government-directed investment and credit booms have gone too far and that much slower growth or even a property crash awaits the world's No. 2 economy.

But with growth in advanced economies still painfully slow, investors say they can't afford to turn their backs on China altogether. Most acknowledge that the years of 10 percent growth or better may be over. They're just not willing to bet the Middle Kingdom will go from boom to bust overnight.

"Yes, on the whole, there are concerns about China," said Samarjit Shankar, director of global FX strategy at BNY Mellon in Boston. "But when it comes to investment opportunities, sometimes you have to pick the least of several evils."

Some portfolio managers even noted that a 20 percent drop in major stock indexes in China and Brazil last year make emerging market equities even more attractive.

According to fund tracker EPFR global, emerging market equity funds absorbed $1.84 billion in the week ending Jan. 11, nearly a third of all new equity investments and the first inflow since November.

"We're concerned about the economies but we like the markets, which are trading at a huge discount to the U.S.," said Jack Ablin, chief investment officer at Harris Private Bank.

"China is entering a risky period and it's hard to know how it will play out," he said. "If I could buy emerging markets ex-China, I probably would. But valuations are such that we're going to hold our nose and buy it too."

Gradual Slowdown or Crash?

For investors who still want exposure to China, sticking to their guns has become harder amid all the talk of coming doom.

Jim Chanos, president of $6 billion hedge fund Kynikos Associates and a long-time China skeptic, has been predicting a hard landing for years, warning that Chinese banks are buried in bad loans that they may not be able to absorb.

In late 2011, he told Reuters that China's comeuppance for letting a real estate bubble form was "already happening," comparing a 40 percent annual drop in apartment sales to the sorts of declines that preceded crashes in Florida and Nevada.

Data this week showed China's economy grew at its slowest pace in 2-1/2 years in the fourth quarter while annual growth fell to 9.2 percent from 10.4 percent in 2010.

The nightmare scenario would involve the economy suddenly slowing to a 5- or 6-percent growth rate. While that would still outpace the West, it would threaten China's ability to keep its urbanizing population employed and could spark social unrest.

It would also have a major impact on global growth, especially for providers of energy and raw materials, at a time when the world is depending on emerging markets to stoke demand.

In a November report, Japanese securities firm Nomura predicted a one-in-three chance of a hard landing, which it defined as an abrupt slowdown to 5 percent growth for at least one year, by the end of 2014.

"If China has a hard landing in the next few years, that will hurt everyone, said David Woo, head of global rates and currency research at Bank of America-Merrill Lynch. "It will cancel out any positive effect from stronger U.S. growth."

But things might not be that gloomy.

For one thing, with some $3 trillion in currency reserves, China has flexibility to cushion the impact of any slowdown. What's more, the central bank has plenty of room to cut interest rates and has already slashed bank reserve requirements.

Others point to an impending leadership change in late 2012, noting that Beijing will do whatever it takes to ensure there is no economic turmoil to hinder a smooth transition.

"We don't believe 2012 is the year we see sub-6 pct growth in China," said Luz Padilla, manager of DoubleLine's $750 million Emerging Market Fixed Income Fund, part of the $22 billion overseen by the Los Angeles-based investment firm. "We think it moderates but remains robust at just over 8 percent."

That's why Marc Doss, regional chief investment officer at Wells Fargo Private Bank, with assets worth $157 billion, said investors will rue getting too bearish too soon.

He said a portfolio that mixes emerging market stocks and bonds with U.S. municipal and high-yield debt and global dividend stocks could return up to 3 percent.

That compares favorably with the S&P 500's flat return in 2011 or the sub-2 percent returns on offer from 10-year U.S., German, Japanese or British government bonds.

"A 10-year Treasury at 2 percent or under is a losing proposition," he said. "With inflation, you're already losing. If you just look at a simple basket of emerging market equities, the dividend yield is higher than the 10-year Treasury."

Hedging Bets

Of course, most investors do expect the pace of growth to slow over the next several years, which is why Padilla said she takes precautions by making sure Chinese fixed income holdings are concentrated in investment grade corporate debt. Among other things, that weeds out exposure to the property sector.

Across emerging markets, she said she sticks to dollar-denominated debt, which should offer some protection if Europe's crisis worsens, sparking slower world growth and a global rush into the safe-haven U.S. dollar.

"We were getting calls almost every day from investors, asking why we aren't in emerging market currency debt," she said. "While I agree that in the long-term that's probably a winning position, what people miss is the risk argument."

To offset his positions in emerging market stocks, Harris Private Bank's Ablin said he had reduced exposure to commodities in general and industrial metals in particular.

Schamotta said he has started advising clients to tread carefully in China, and advises liberal use of options and forward contracts to lock in favorable rates in the yuan or currencies of countries like Australia, where growth is closely tied to the strength of the Chinese economy.

But he's not expecting too many to bail out entirely.

"The psychology of the typical chief financial officer or investor reminds me of that line about musical chairs," he said. "They have to keep at it as long as the music's playing."

Source Reuters