China’s mainland stock exchange has been red hot over the past year and may get another big lift now that MSCI Inc. is anticipated to add domestically listed A-shares to its influential global market indexes, making it easier for investors to access them.
But it\’s Chinese H-shares traded in Hong Kong that may offer the best value to investors in the longer run.
“China\’s domestic equity markets look frothy after more than doubling in 12 months,” said BlackRock Investment Institute in its latest report.
“We prefer less expensive Hong Kong-listed Chinese equities, especially small and medium-sized stocks, simply because they have a break down liquidity discount that\’s set to dissipate.”
A-shares have traditionally only been available to buy by China’s mainland citizens, with foreign investors having limited access through a tightly regulated program known as the Qualified Foreign Institutional Investor (QFII) system.
H-shares, by comparison, trade in Hong Kong or other international stock markets and therefore are widely available to all investors with a few exceptions including mutual funds in mainland China, which have restricted access.
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The divide forwards and backwards markets helps create a valuation gap which has resulted in A-shares trading confined to H-shares through the years, but this premium is continuing to grow larger recently, making the latter even more attractive on the relative basis, BlackRock said.
“We have seen value in H-shares of selected banks, property developers, utilities and new energy,” the asset manager said in its report. “We also like small , medium-sized companies in the H-share market. These trade at only a small premium to large caps, compared with the segment\’s 150% higher P/E ratios within the A-share market.”
BlackRock said poor liquidity is the main factor contributing to this valuation gap, but it expects this to narrow as tries to reduce capital controls across both markets be prevalent.
The relatively recent Shanghai-Hong Kong Stock Connect program, for instance, lets overseas investors trade a capped amount of stocks on the Shanghai exchange, while funds in mainland China can purchase and sell selected Hong Kong-listed equities.
Such programs may eventually level the arena, but it is A-shares that could receive the greatest short-term benefit as China continues to increase global market use of them.
Kevin Ferriter, a market economist at Capital Economics, said only 1 / 2 of the total quota for the Shanghai-Hong Kong connect has been utilized so far, leaving 150 billion renminbi (US$25 billion) in room that could be quickly used up.
There may also be huge global investor implications depending on the extent that A-shares are included in MSCI’s emerging market index, he said.
For one, the index’s volatility would probably increase, since it would be more focused on one country and A-shares have were rather highly volatile.
Secondly, Ferriter said hello could boost China\’s domestic stock market as investors in emerging Asian and broader emerging-market indexes adjust their portfolios.
“Ultimately, foreign investors may need more market use of be granted before they are able to rebalance their portfolios fully,” he explained.