Schroders Quickview: Hong Kong market momentum not based on fundamentals
The recent euphoric rally in Hong Kong shares has largely been driven by valuation gaps and positive regulatory support for mainland investors to invest in the Hong Kong market.
10 April 2015
The surge in Hong Kong’s stockmarket on Thursday has added a second consecutive day of strong gains as liquidity and bullish sentiment on domestic China A-shares is having a spillover effect on the Hong Kong market.
Meanwhile, the valuation gap between A shares (listed in China) and H shares (listed in Hong Kong) has widened considerably recently as the Shanghai Composite has risen over 90% since late June last year.
Mind the valuation gap
We believe this valuation gap between select A and H shares, in an environment where regulators are gradually lowering the barriers to the Hong Kong market for mainland investors, is driving mainland fund inflows into the market.
Clearly, this is serving as a positive catalyst for the near-term rally.
On the reform front, the China Securities Regulatory Commission (CSRC) announced new guidance at the end of March for publicly offered securities investment funds (i.e. mutual funds) in China to invest in Hong Kong-listed equities through the Shanghai-Hong Kong Stock Connect Scheme.
The Southbound component of the stock connect scheme allows eligible investors, with at least 500,000 Yuan in their trading account, to buy a select range of Hong Kong-listed stocks.
Obstacles to investing in Honk Kong removed
By removing a pre-approved qualification process for onshore mutual funds, these funds can now invest through the Southbound scheme.
This trend of sharp rises in share prices has been reflected by the substantial increase in trading volume of late.
In addition, Southbound investment with the Shanghai-Hong Kong Stock Connect Scheme has surged to its highest level since the programme was launched in November 2014.
Are China's H-shares priced for perfection?
The rising A/H premium could also serve as another factor that drives China onshore capital south.
Chinese investors were increasingly looking to capitalise on the price gaps between onshore and offshore markets.
Yesterday’s moves took the average premium of domestic-listed A-shares over Hong Kong-listed H-shares down from 35% to 28%.
With the A-share market still rising in spite of weak economic data and poor company earnings in China, H shares are becoming an increasingly attractive alternative.
However, valuations are generally starting to look expensive which makes us cautious about chasing some stocks.
What next for China's mutual funds?
What has happened in fund flows could be just the beginning.
This is because the majority of China domestic mutual funds have their mandates limited to A-share investments.
To participate in the Southbound trade under the new guidance, they will need to launch new products or modify existing mandates.
Sticking with the fundamentals
Whilst the broader macro and policy-driven environment brings up interesting investment themes and ideas, our focus remains on taking a disciplined bottom-up approach to active investing and selecting quality businesses with strong fundamentals.
As China works through its reform agenda, the initial and obvious opportunities around broader sectors and themes will make way for more discerning stock selection to drive longer term returns.
Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.