The game-changing agreement to give Hong Kong and mainland investors limited, but more seamless, access to each other’s equity markets marks an important new phase in China’s integration into the global market matrix. Implemented on a trial basis, the cross-border trading mechanism grants mainland China investors unprecedented, direct access to a subset of Hong Kong-traded equities, and vice-versa.
In the short run, it’s difficult to predict the degree to which the new trading centre of gravity will shift. The answer hinges largely on the valuation levels and investor sentiment in both markets. Looking ahead, we believe the impact will be mutually beneficial: the expanding universe of tradeable stocks and the swelling ranks of market participants will enhance liquidity and promote market rationality, as stock prices fully reflect information owned by both domestic and foreign investors.
Will Shanghai and Hong Kong Investors Make a Run for the Border?
With the upcoming rollout of cross-border trade and increasing economic integration between the two economies, we expect both mainland and foreign investors to reach across the border in progressively greater numbers. We’ve witnessed strong demand from mainland investors to invest abroad, given their rapidly growing private wealth in China, and the desire of the wealthy to spread their risk exposure beyond the Middle Kingdom. Previously, due to the long-time financial repression in China, investors’ options were few. These included low-yield bank deposits, a limited supply of bonds, and properties.
However, thanks to China’s progressive new reform measures, investors’ choices are now meaningfully broader, and substantially more appealing: higher-yield money market funds, bank wealth management products, and asset management plans offered by trust and brokerage firms. Wealthy investors continue to seek out ways to diversify away their country risk and property risk, as the China economy remains soft. According to China Merchants Bank’s 2013 China Private Wealth Report, total personal investable assets grew 14%, compounded annually, to CNY 80 trillion between 2010 and 2012. Overseas investments became a hot spot, with a 30% average growth, while growth rate in the domestic stock market and property market investments slowed during the same period.
As overseas investments accounted for less than 5% of total investable assets, we expect great upside potential, as the government is progressively lifting the restriction on capital accounts.
We’ve also found a growing appetite for overseas investments among China’s high net worth individuals (who collectively own CNY 22 trillion in investable assets, representing 27.5% of total wealth). More than 37% of them are interested in investing abroad, with 30% already having done so. Given the disappointing performance and mainland investors’ taste for short-term investing, we expect seasoned, individual mainland investors to find appeal in the more developed Hong Kong stock market.
Despite their strong aspiration to invest abroad for the sake of risk diversification, China’s high interest rate environment could hold back their cross-border investment at the current stage.
From the perspective of Hong Kong stock investors, we believe the trial run conveys a favourable signal that the Chinese government will hasten the pace of financial reforms, and gradually open its capital markets to foreign investors. The less efficient mainland stock market could become an attractive place for bargain-hunting overseas investors.
Our Take: Attractive Investment Opportunities
Except for the financial stocks, including stock exchanges and brokerages which saw direct benefits, we don’t believe the new Shanghai-Hong Kong exchange link will have a significant impact on any given company’s fundamentals. Rather, by granting mutual market access, the trial run will improve both supply and demand in both markets. Over the long haul, we expect it to lead to improved market efficiency despite higher volatility, especially for the mainland stock market, as a result of increased cross-border money flows, and of stock prices now reflecting all information known to substantially broader categories of investors.
We find three types of investment opportunities worth investors’ attention.
First, we expect some short-lived arbitrage opportunities of buying in undervalued corresponding stocks for those A/H shares trading with a substantial A/H price gap. The large A/H price gap should be reduced to a reasonable level to reflect any discrepancy in underlying transaction costs between the two markets.
Second, we expect foreign investors will favour high dividend-paying stocks in the mainland stock market. Our reasoning is predicated on the follows: (1) the expectation of CNY appreciation in the longer run means that investors will obtain higher total value of investing in terms of foreign currency by the end of their investment period, relative to comparable high-yield stocks in Hong Kong market; (2) the differentiated individual dividend income tax policy in the mainland stock market, where the tax rate falls to 5% from 10% for investors holding stocks longer than one year, would be a plus for Hong Kong investors if the same tax policy applies.
The third investment opportunity lies in those stocks with unique business exposure where there’s no or very limited supply in the other market, including Chinese medicine and white spirits in the mainland stock market, and gambling, luxury brands, mature Internet companies, new energy, and foreign companies listed in the Hong Kong market.
