Pondering on stock market (XINHUA)

As the Chinese mainland 's Growth Enterprise Market (GEM) prepares to begin trade in October, some experts have warned investors to be aware of the high risk. Pi Haizhou, an independent economic observer in China, told New Finance & Economics monthly magazine recently that small and medium investors are unlikely to make any money on the GEM. His comments follow:

A dream

July 15, 2009 marked the first day that ordinary investors could open accounts on the GEM, or the second market, implying that the GEM had its own clients from then on.

The launch of the GEM has fueled so many fantasies for people in China.

Management departments hope the establishment of another capital market will help set up a multi-level market system and provide a financing platform for small and medium-sized enterprises (SMEs). They also hope the launch of the second board will benefit SMEs amid the impact of the global financial crisis.

GEM-listed SMEs expect to raise substantial funds by issuing stocks, so as to solve the problem of funding shortage, promote their development, and forge their businesses into strong ones. In addition, the heads of these businesses anticipate becoming upstarts on the new stock exchange. Venture capital companies and securities traders are looking forward to raking in money.

Ordinary investors yearn to share in the "fruits" of these enterprises, and some even hope to discover "China's Microsoft" on the GEM. All of this indicates how much people expect from the second market.

Risk

GEM is actually a venture capital market, and a risky one at that. Yao Gang, Vice Chairman of the China Securities Regulatory Commission (CSRC), once listed six major risks of GEM trading. They include risks for GEM-listed companies in terms of operation, credit, share price fluctuation and technology, in addition to the risks from investors ' blind investment and the risks of intermediary institutions. But the greatest risk lies in the GEM system and its supervision.

First, GEM-listed companies might not perform well. Mostly SMEs, they are small in scale, weak in competence, and low in yield and credibility. To satisfy their desire to go public, the threshold to be listed on the GEM is lower than that for the main board. Due to the high risks, banks used to be reluctant to offer them loans, so the risks for investors are obvious.

Second, it is easy for speculators to manipulate the share prices of GEM-listed companies because of the small equity in trading. Due to the lack of internal management, illegal inside trading may happen. As a result, investors will become victims of these unlawful activities.

Third, the exit system of the GEM is stricter than that of the main market, which will lead more enterprises to drop out.

GEM started a fast exit program to promote the market 's performance, shorten the exit time span, and avoid long-term suspension of trading.

In accordance with the published rules for listing on the GEM board, for example, GEM-listed companies exit the market directly without listing on another market as required by the main board.

If a listed company fails to publish a regular report, it will be ordered out of the market in three months, as compared with six months on the main board.

If a listed company 's net assets are in the red, trading of its shares will be suspended temporarily and whether trading resumes will depend on the company's half-year report instead of the annual report as it does on the main board.

As a result, GEM-listed companies are more likely to exit the second market compared with those on the main market. Statistics show that some 20 percent of listed companies on the NASDAQ market are forced out of the market in any given year.

Given the high risk, GEM traders should not assume they will discover "China's Microsoft," otherwise they could lose their assets.

A pie in the sky

Indeed, some dreams may come true on the second market. But the dreams that come true usually belong to management departments and some SMEs, as well as venture capital companies. The search for "China's Microsoft" is like looking for a needle in a haystack.

What is the probability of finding a successful business on the GEM, and how much should an investor pay?

It is important for investors to review their experiences on the stock market and acknowledge how difficult it is to find success. One example is PetroChina Co. Ltd., China 's biggest oil producer, known as the most profitable company in Asia.

The company listed its A-shares on the Shanghai Security Market in November 2007 at a price of 48 yuan per share. The price later dropped to 9 yuan and currently stands at just over 13 yuan. Investors suffered losses by buying shares in such a big business, so how much more difficult will it be to profit from investing in companies listed on the second board?

When Chinese investors hear the GEM mentioned, it conjures up names like Microsoft, Intel and Google, symbols of the success of the American NASDAQ. Investors in these companies have gained significantly from their growth.

But the success of some SMEs on NASDAQ is due to its sound investment environment. Take the strict market supervision as an example. NASDAQ-listed companies risk being booted from the market if they issue false information or fail to issue their financial statements on time.

Moreover, examples of failure abound in countries and regions worldwide.

The German GEM, full of worthless garbage shares, came under harsh public criticism and had to close after five years of operation. The growth enterprise markets in both Australia and New Zealand closed in 2001, the former having opened and closed three times before it shut down for good. In Hong Kong, the second market has plunged by 90 percent, with many shares worth only HK$1 at one point. A few competitive companies have left or intend to list on the Shanghai market.

In 2001, when the dot-com bubble burst, more than 80 percent of Internet companies became insolvent even on NASDAQ, and only a few of these companies continue operations today.

As a result, though I wish the domestic GEM well, investors need to keep a sober mind as they wait for it to open, given the numerous times others have failed.