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July 10 (Bloomberg) -- Some of the world’s biggest stock investors are shifting their China bets to mainland companies from Hong Kong after the city’s shares climbed to the most expensive levels in 12 years.
The MSCI Hong Kong Index traded at 16 times reported earnings at the end of June, versus a multiple of 9.8 for the MSCI China index, the widest gap since 2002. Hong Kong’s gauge has outperformed the China measure for four straight years, rallying 160 percent from its low amid the global credit freeze.
Amundi Asset Management, Credit Suisse Group AG and Sumitomo Mitsui Trust Bank Ltd., which oversee almost $3 trillion, say Hong Kong stocks will struggle as reduced Federal Reserve stimulus weighs on developers and banks that make up more than 35 percent of the index. The investors have joined BlackRock Inc., the world’s largest money manager, in favoring Chinese shares amid signs Premier Li Keqiang is succeeding in efforts to keep economic growth from falling below 7.5 percent.
“We are positive on China and believe the market is too cheap,” said Ayaz Ebrahim, the Hong Kong-based chief investment officer of Asia ex-Japan equities at Amundi, which oversees about $1 trillion worldwide. “We’ve been gradually taking Hong Kong stocks off the table.”
Strategists from at least five of the world’s biggest banks are also retreating from equities in the former British colony, which was returned to Chinese rule in 1997. HSBC Holdings Plc, UBS AG, Standard Chartered Plc, BNP Paribas SA and Citigroup Inc. have all downgraded their recommendations on Hong Kong shares since the end of May.
The city of 7.2 million has a closer link to America’s monetary policy than does China because the Hong Kong dollar is pegged to the greenback and its economy is more open to international capital flows. Hong Kong’s residential real estate prices have more than doubled since the end of 2008, when the Fed cut its benchmark lending rate to a record-low near zero.
The surge helped make Sun Hung Kai Properties Co. and Cheung Kong Holdings Ltd., controlled by Li Ka-shing, Asia’s richest man, among the world’s three-largest listed property companies by market value.
Fed policy makers are paring their monthly pace of asset purchases and traders see about a 62 percent chance the central bank will increase its benchmark rate to at least 0.5 percent by July 2015, based on federal fund futures contracts.
Higher borrowing costs may weigh on a Hong Kong market that’s already grappling with falling retail sales, a pro- democracy movement that spurred the city’s biggest protest march in a decade this month and weak corporate earnings, HSBC, the bank founded in Hong Kong in 1865, wrote in a research report this week. The firm has an underweight rating on Hong Kong shares and is overweight on China.
On the mainland, policy makers have lowered reserve requirements for some lenders, sped up spending of state funds and announced plans to build railways, helping the nation’s manufacturing industries expand in June at the fastest pace this year. Premier Li said in a speech in London last month that the government is “adjusting its economic operations to ensure the minimum growth rate is 7.5 percent.”
“China will perform better than Hong Kong in the third quarter,” Fan Cheuk Wan, the chief investment officer for Asia- Pacific at Credit Suisse’s private banking and wealth management unit, said at a press briefing on July 7. “The China equity market is well-positioned to see a tactical rebound on the back of growth stabilization.”
The 140-member MSCI China Index rose 0.3 percent today, paring its decline this year to 1.7 percent. Its Hong Kong counterpart also added 0.3 percent today and has gained 3.2 percent in 2014. While both indexes are comprised of shares listed in Hong Kong, they have different constituents with no overlap.
Companies in Hong Kong tend to be more transparent and better run than those in China and many offer similar ways to profit from growth on the mainland, according to Aberdeen Asset Management Plc. Hong Kong ranks No. 2 on the World Bank’s ease of doing business survey, versus 96 for China.
“We access China very much through Hong Kong companies because of the better governance, higher regulatory requirements, better financial reporting,” Nicholas Yeo, a money manager at Aberdeen Asset, which oversees about $541 billion worldwide, said on July 4 from Hong Kong. “We still do not find enough quality companies in China.”
Hong Kong stocks have weathered previous periods of monetary tightening by the Fed. The MSCI Hong Kong gauge surged 66 percent in the 12 months before the U.S. central bank began raising interest rates in June 1999, then added an additional 3.2 percent in the following 12 months. When the Fed started boosting borrowing costs in June 2004, the gauge climbed 23 percent over the next year.
The city may be more vulnerable to rising interest rates this time around after household debt as a proportion of gross domestic product climbed to a record 62 percent, according to a June 26 report by the Hong Kong Monetary Authority. Property prices will probably drop 20 percent by the end of 2016, according to BNP Paribas.
“There will be a higher risk premium on Hong Kong equities, especially the construction and the real estate market,” Alain Bokobza, the head of global asset allocation at Societe Generale SA, said by phone from Paris. He favors Chinese shares because low inflation gives the central bank room to combat the impact of falling property prices with looser monetary policy.
The combination of central bank support, signs of shareholder-friendly reform in the energy industry and low valuations have spurred BlackRock to take an overweight position in China, Andrew Swan, the head of Asian equities at the New York-based money manager, which oversees about $4.3 trillion, said on June 24. The firm is underweight Hong Kong.
“Chinese companies are likely to benefit more from this economic recovery than companies in MSCI Hong Kong,” Katsumi Takagaki, the Hong Kong-based investment officer at Sumitomo Mitsui Trust (HK) Ltd., whose parent oversees about $474 billion, said by phone on July 4. China “has rolled out stimulus and is moving toward looser monetary policy.”
--With assistance from Celine Ge in Hong Kong and Nikolaj Gammeltoft in New York.