Between the Lines: It's harder than it looks to grab a piece of China's action

CHINA might seem the obvious choice for investors starved of returns but even as its economy becomes the world's second largest there's a danger in biting off more than you can chew.

Only the US stands in the way of China being the world's biggest economy after Japanese GDP growth of 0.1 per cent in the last quarter saw China finally move into second place. PricewaterhouseCoopers and the World Bank are among those expecting the latter to supercede the US as soon as 2020.

China's long march to economic hegemony might imply that investors merely need to ensure the growth of the Chinese economy is reflected in their portfolios to ensure success. Two thirds of financial advisers believe investors need to increase their exposure to emerging markets, with China viewed as the number one opportunity.

But it's not that simple - nowhere near it in fact. For a start, economic growth does not translate seamlessly into stock market growth, and that applies to any economy. The Chinese stock market currently yields around 2.6 per cent and many believe that it is overpriced. Investors also take on considerable volatility by focusing excessively on individual companies or countries, whether it's China, India or the US. Similarly, an issue I have with fund managers investing in China from afar is that regular visits are not enough to get a feel for what's happening, particularly when those visits are limited to the great coastal cities. The modern Chinese revolution is happening a long way from Beijing and Shanghai, and the biggest challenge facing the Chinese administration is in managing the impact of its economic growth on not just the rural communities but the dozens of massive inland cities that many people outside China will never have heard of.

Inland China faces huge social problems, most notably poverty, inequality and the implications on its demographics of the one-child policy. There's not only social unrest, as the pace of urbanisation and the rapid growth of a Chinese middle class create new social dynamics, but escalating protests at the conditions in factories churning out white goods such as iPads. But the way in which that plays out politically, and the long-term implications for the economy, is best understood on the ground.

So how can investors profit from China's economic growth? Increasingly, there's no need to take on the extra volatility of investing directly in Asian stocks. Some 70 per cent of the revenue produced by companies in the FTSE 100 is derived from outside the UK, and that increasingly means revenue generated from meeting demand generated by Asia.

Not only that, but by investing in Asia vicariously through FTSE firms with a global reach investors are also assured of a higher level of corporate governance - and, in theory, transparency - than is likely in locally listed companies.

For fund investors, global growth and emerging markets vehicles are more logical. The biggest name in fund management now invests in China, with Anthony Bolton's Fidelity China Special Situations trust pulling in 460 million at launch earlier this year. But there is considerably more experience in broader emerging markets funds, with the likes of Templeton's Mark Mobius, Hugh Young of Aberdeen and Angus Tulloch at First State bringing to the table the knowledge that is vital in understanding developing economies.

A good emerging markets fund is a far better bet than one focused on China. Diversification is the obvious reason, but there's also the opportunity for investors to gain exposure to the India story - in its way every bit as compelling as China's - and Latin America, most notably Brazil. Like China, India has more than a billion people. Unlike China, it is a democracy with a massive and growing young population, boasting around a quarter of the world's under-25s.

Global growth and some emerging markets funds also invest in Japan. And while Japan is understandably unloved by investors after producing so few returns in recent years, Japanese companies look "extremely cheap", according to Adrian Lowcock of Bestinvest. He pointed out that there are plenty of Japanese companies with dividend yields over 10 per cent, while the Japanese yen plays the role of a "safe haven" currency along with the dollar, at least while interest rates are low.