By Lucy Ren

Despite recent slowdowns in the Chinese economy’s growth rate and persisting market vulnerability, the Chinese stock market has rallied to a seven-year high. Market experts anticipate greater momentum for growth and interest in the Chinese market despite its irrational nature.

In May the Shanghai Stock Exchange Composite Index bounded up 8.3 percent to 4657.6, the highest level since December 2007. The Hong Kong benchmark Hang Seng Index soared almost 13 percent in April, marking the largest monthly gain since April 2009. By contrast, the Hong Kong index experienced just moderate fluctuation in May, closing at 27992.8 on Friday.

Paralleling the recent rallies in the stock markets, actively managed U.S. funds invested in the Chinese market have also seen record-high returns.

“The market doesn’t usually react rationally,” said Gregg Wolper, senior mutual-fund analyst at Morningstar Inc. “It seems like the local investors are just very excited about the market, so they are pushing it up.”

According to an index compiled by Chicago-based Hedge Fund Research Inc., returns of hedge funds that focus on Chinese stocks have accelerated through 2015, most recently shown by a muscular gain of 13 percent in April, the highest monthly return since the index was created in 2008.

In comparison, the emerging markets-focused hedge funds as a whole, including China, gained less than 7 percent in April.

Four months into 2015, hedge funds investing in China have already achieved a lofty return of 18.76 percent, far exceeding the hedge fund industry’s average of 3.07 percent, according to the HFRI Fund Weighted Composite Index of more than 2000 funds across strategies and regions.

Returns of mutual funds investing in Chinese stocks have gained by more than 20 percent in the first four months of 2015, compared with a weak 1.5 percent return in 2014, according to data provided by Morningstar.

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However, wild swings are not unusual in China’s stock market. According to data compiled by the Chicago-based research firm, from 2007 to 2009 China-focused mutual funds have either gained or lost by more than 50 percent annually.

“Emerging markets like China tend to be very volatile because investors get more excited about the prospects when something good happens, and more pessimistic if there are some concerns,” said Wolper.

The Matthews China Fund, which seeks long-term appreciation of Chinese common and preferred stocks, bounded upward by almost 40 percent in April, the highest monthly return since the fund was created in 2005.

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Most U.S. investors seeking exposure to the Chinese market buy exchange traded funds investing in China-based corporations.

Passive funds like ETFs have much lower costs than actively managed mutual funds and hedge funds, but are subject to more political influences because the largest companies in those funds are state-controlled businesses.

“They may be run according to government reasons which may not be the best for the business in the long term,” Wolper explained.

On the other hand, actively managed mutual funds give fund managers the freedom to choose what stocks to own.

Shirley Luo is a senior analyst at Puissance Capital Management, a hedge fund firm focusing on credit and equity investments in U.S. and Chinese markets. She attributes the recent gains in China funds to the launching of the Shanghai-Hong Kong Stock Connect in November.

For the first time, investors in each market are able to trade on the other market using their local brokers and clearing houses.

Under the new scheme, investors theoretically are able to short  certain securities listed on the Chinese market, meaning that investors can now borrow the security in order to sell it and subsequently repurchase it from the original seller. Short sellers make money when the shorted security falls in value.

However, fund managers soon realized that short selling is subject to many limitations, such as the types and the quantity of securities that could be short sold.

“So when stocks are moving in one direction, it usually moves by a lot,” Luo said, underscoring the inflexibility of selling short on the Chinese market.

In addition to the opportunities created by the Stock Connect, the growing anticipation of accommodative monetary policy will continue to fuel the stock rallies, Luo said. Early in May the China central bank cut interest rates for the third time in six months, as part of a continuing stimulus plan to boost economic activity amid signals of a marked slowdown in the rate of expansion.

A recent report by the International Monetary Fund forecasted that China’s GDP growth rate will slip to 6.8 percent in 2015, compared with a growth of 7.4 percent last year. The HSBC China Manufacturing PMI also pointed to a further deterioration in operating conditions in April. The index slipped to 48.9, below the neutral value of 50, from 59.6, marking the first monthly decline in 2015.

The China region stock markets carry a lot of noise, and often expose investors to greater volatility and risk than other markets do, Morningstar’s Wolper asserted. Last week, three huge Hong Kong-listed companies lost half of their values without a single distinct explanation.

“I think a lot of investors in China understand that things like that can happen in China,” Wolper said. “I don’t think it would be a complete shock to them.”

“I think [China] will continue to be a great area of interest for investors, one way or another, but it is still too hard to predict its equity market,” Wolper added.