Shanghai-Hong Kong Link Spurs Record Buying of Mainland ETFs

Aug 14, 2014 9:53 am ET

(Updates flows in second paragraph.)

Aug. 14 (Bloomberg) -- The Shanghai-to-Hong Kong stock price convergence trade is spurring record inflows into exchange-traded funds that invest in mainland China.

The two biggest ETFs tracking China’s A shares lured about $2.5 billion from the end of May through yesterday, the most for any similar period since they both started trading. By contrast, the largest ETFs that buy Hong Kong-traded Chinese companies, known as H shares, posted just $67 million of inflows.

Investors are betting valuation discounts of about 8 percent for A shares will narrow as a link between exchanges in Shanghai and Hong Kong, scheduled to start in about two months, makes it easier for arbitragers to close gaps between dual- listed securities. The ETFs are getting an added boost from signs that China’s ruling Communist Party will take steps to keep growth in the world’s second-largest economy from falling below its 7.5 percent annual target.

“Why would you buy the Hong Kong stocks if you could buy them in the mainland at a discount?,” Brendan Ahern, managing director at New York-based Krane Fund Advisors LLC, said in a phone interview yesterday. “You might be able to capture that gap with the connect coming online.”

The inflows have been so big that some fund managers are seeking additional quotas from Chinese regulators, which currently allow only qualified institutions to access the mainland market. CSOP Asset Management Ltd., which runs the second-largest ETF investing in mainland shares, said on July 30 that most of the existing quota for its fund has been used.

Deeper Discount

“We are begging for more quota,” Cheah Cheng Hye, chairman of Hong Kong-based Value Partners Group, which runs the best-performing Greater China equity fund during the past five years, said Aug. 2. “We think the A-share market has become too cheap.”

Since China unveiled plans to connect the bourses in April, the Hang Seng China AH Premium Index, which trades at 100 when prices between dual-listed shares are equal, has fallen 2.1 percent, signaling a deeper discount for mainland stocks. It rose 0.1 percent to 91.63 today.

The gap will disappear as the exchange tie-up leads to the creation of a “one-China” market, Jonathan Garner, the head of Asia and emerging-market strategy at Morgan Stanley, said in a Bloomberg Television interview on Aug. 12.

The iShares FTSE A50 China Index ETF has attracted the equivalent of $598 million since the end of May, while the CSOP FTSE China A50 ETF lured $1.88 billion, according to data compiled by Bloomberg. The iShares China Large-Cap ETF, the biggest investing in H shares, had $300 million of inflows while the H-Share Index ETF posted outflows of $234 million.

Selective Investors

“It’s a good time to rediscover the value in A-shares,” Ko Tseng, Hong Kong-based managing director of E Fund Management (HK) Ltd., whose E Fund CES China 120 Index ETF invests in both A shares and H shares, said in an Aug. 1 interview.

While China’s economic growth accelerated to 7.5 percent in April-June following a two-quarter slowdown, government data yesterday showed new credit growth for July plunged to the lowest since October 2008 as industrial output expansion slowed. Home sales last month declined the most this year as prices and demand weakened.

The Shanghai Composite Index rose yesterday and the Hang Seng China Enterprises Index rallied to an eight-month high amid speculation the government will take further steps to support the economy. The Bloomberg index of the most-actively traded Chinese companies in the U.S. climbed 1.4 percent, extending its 2014 advance to 9.7 percent.

Buying Opportunities

The Shanghai gauge has rebounded 12 percent from this year’s low in January, while the H-shares gauge entered a bull market in July after policy makers took steps to counter the slowdown including accelerating railway spending, allowing cities to loosen property curbs and cutting reserve-requirement ratios for some lenders.

The exchange tie-up will provide opportunities to foreign asset managers to invest in Chinese companies they didn’t have access to from the H-share market. Firms such as Baoshan Iron & Steel Co., China’s biggest publicly traded steelmaker, and Kweichow Moutai Co., the nation’s biggest liquor maker, are only listed on the Shanghai stock exchange.

“Where the best companies are in the industry is in the A- share market, not the H,” Charlie Awdry, portfolio manager of Henderson Global Investors Ltd.’s China Opportunities Fund, said by phone from London yesterday. “We would like to go and buy that.”

--With assistance from Allen Wan in Shanghai.