Investment Insights Southbound liquidity is a structural positive for H-shares+

Transcription

1 Investment Insights Southbound liquidity is a structural positive for H-shares+ October 17 We are seeing strong flows from mainland Chinese investors into a broad group of Hong Kong-listed Chinese equity stocks that we call H-shares+. 1 Currently, the MSCI China Index consists entirely of Hong Kong-listed Chinese equity companies (i.e., H-shares+) and offshore American Depositary Receipts (ADRs). 2 Year-to-date, US$28 billion has flowed into the Hong Kong stock market. 3 Mike Shiao Chief Investment Officer, Asia ex Japan William Yuen Associate Director, Investment A-shares: refers to companies listed on mainland Shanghai and Shenzhen stock exchanges. China ADRs: Chinese companies listed as offshore American Depositary Receipts H-shares: are defined by the Hong Kong Stock Exchange as companies that are incorporated in mainland China and whose listings in Hong Kong are approved by the China Securities Regulatory Commission (CSRC). Our view is that there will be structural allocation by mainland Chinese investors into the Hong Kong stock market a development made possible by the Stock Connect program s Southbound Trading Link. This paper covers the incentives for mainland investors to invest via the Southbound Trading Link, and the reasons why we believe this trend is long-term in nature. Four ways H-shares+ may benefit mainland Chinese investors Interest in H-shares+ has been strong since the launch of the Stock Connect program, for the following reasons: Unique investment opportunities: An expanding investment universe allows mainland Chinese investors to access unique opportunities and industry leaders in the Hong Kong stock market. There are leaders in different industries that are listed as H-shares+ on the Hong Kong exchange, but not as A-shares on the Shanghai and Shenzhen exchanges. Examples include mobile telecom giant China Mobile and the Chinese national oil company, China National Offshore Oil Corporation (CNOOC). Based on their top net buys via the Southbound Trading Link, mainland Chinese investors are looking to Hong Kong for companies that could potentially provide relatively attractive yield and return. Valuation differentials: For a number of dual-listed Chinese companies, H-shares have been trading at a discount to their A-shares equivalent. The Southbound Trading Link has made it possible to take advantage of this valuation differential. Higher southbound flows have caused this discount to narrow (from about 60% in late 15 to 44% as of Sept. 28, 17) 4, but we believe there are still plenty of opportunities, especially in nonmega-cap stocks. There is still a large discount for H-shares as seen in the equal-weighted A/H premium shown below. The A/H premium is the difference in pricing between A shares and H shares. A shares have historically traded at a premium to H shares. Chart 1: China A-H Premium Equal-weighted A/H premium Cap-weighted A/H premium % What are the Stock Connect program and Southbound Trading Link? Stock Connect is a cross-boundary investment channel launched in November 14 that connects the Shanghai Stock Exchange and the Hong Kong Stock Exchange. Under the program, investors in each market are able to trade shares on the other market using their local brokers and clearing houses. The Southbound Trading Link refers to qualified mainland Chinese investors investing in eligible HKlisted stocks. Correspondingly, the Northbound trading link allows global investors to access China domestic A-shares listed on the Shanghai and Shenzhen stock exchanges Source: Bloomberg, Goldman Sachs Global Investment Research, as of Sept. 30, 17. Past performance is not a guarantee of future results.

2 Lack of offshore investment opportunities: Stock Connect provides mainland investors the most flexible channel to invest offshore. Prior to the launch of the program, Chinese investors mainly utilized the Qualified Domestic Institutional Investors (QDII) quota to invest in H-shares+. Given that many institutional investors QDII quota was not extended due to capital control and other reasons, the Stock Connect program became an important channel for mainland Chinese investors to diversify away from the domestic China A-shares market. Easy access: The Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect have allowed investors a hassle-free way to make cross-border stock purchases between these markets. In particular, the Southbound Trading Link has gained traction among mainland institutional and individual investors, as it is a direct channel for them to structurally allocate to H-shares+ without the constraint of pre-approval, which was needed in previous QDII regimes. Most importantly, we believe neither A-shares nor H-shares+ alone can represent the entire Chinese economy. As mainland Chinese investors typically have a majority of investments in domestic A-shares, we believe investing in H-shares+ will allow mainland Chinese investors to complete the full opportunity set, covering different share classes of Chinese equities. From an asset allocation point of view, investors may need to rethink their strategic allocation to Chinese equities. A-shares companies total market capitalization only took up 73% of China s nominal GDP in Meanwhile, the H-shares+ universe offers approximately 1,105 companies, with a market capitalization of US$ 4.0 trillion. 6 We believe the combined universe enhances the breadth and depth of the investment spectrum, offering investors many investment opportunities that are aligned to the structural growth drivers of the Chinese economy. One example is China Mobile, a leading mobile telecom giant, which is only available in the form of H-shares+. Are flows into H-shares+ here to stay? We expect southbound investors to continue making strategic allocation to H-shares+, providing supportive liquidity to the Hong Kong stock market. Year-to-date, the robust flow of money through the Southbound Trading Link is one of the drivers of the strong performance in the Hong Kong stock market, which rose 29% in US dollar terms. 7 Since launch, there has been strong liquidity flowing to the Hong Kong stock market. On a cumulative basis, southbound flows via Stock Connect reached US$78 billion since the initial launch of the program in November 14, as shown in the chart below. 8 Chart 2: Strong cumulative inflow via Stock Connect since launch Cumulative capital flows to the Hong Kong stock market (US$bn) ETF (ex. Onshore) Southbound Connect Total fund flows Billions 11/14 3/15 7/15 11/15 3/16 7/ /16 +50bn 3/17 7/17 +84bn +78bn bn +bn +39bn 0 - Sources: Bloomberg, EPFR, FactSet, Goldman Sachs Global Investment Research. Note: Fund flows from EM/Asia/Global are multiplied China/HK weights in corresponding MSCI indexes. Investment Insights: Southbound liquidity is a structural positive for H-shares + 2

3 Over the past two years, mainland Chinese investors have become increasingly important for the Hong Kong stock market. In 15 and 16, these investors accounted for % of overseas investor trading volume in the Hong Kong stock market, up from 13% in 14, as shown in Chart 3. 9 Chart 3: Distribution of non-domestic investor trading value in cash market by origin (13 16) US UK & Europe Asia (ex mainland China) Mainland China Others % Sources: HKEX Fact Book 15 and HKEX cash market transaction survey 16, published in July 17. Trading from Mainland China investors included southbound trading through Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect. Some investors may think that the strong flows into the Hong Kong stock market are only transitory in nature. But we believe the southbound flows are structural and are here to stay. Structural flows are not just driven by individual investors, but there is also a meaningful amount of institutional participation following recent deregulations. Following CIRC (China Insurance Regulatory Commission) clarification in late September 16, mainland Chinese insurance companies were permitted to invest their assets in Hong Kong-listed companies via Stock Connect. Moreover, these investments are categorized under the domestic equity category and are not subject to the cap that applies to overseas asset allocation. This regulatory relaxation makes it possible for Chinese insurers to strategically allocate more to H-shares+. In fact, mainland insurers have already invested billion renminbi (about US$25.9 billion) via Stock Connect, making them a major contributor of southbound flows. 10 Examples of H-shares+ invested include telecom and utility names, which could potentially offer insurance companies yields in the midst of a low interest rate environment. Additionally, demand from retail investors via the mutual fund channel has been buoyant. There has been a surge of mainland mutual funds investing via Stock Connect. Since mainland mutual funds became allowed to invest via Stock Connect in March 15, the number of Southbound Stock Connect funds has risen to 98, with total assets under management reaching at least 79 billion renminbi (about US$11.9 billion) going into the Hong Kong stock market. 11 In June, the Chinese government required any newly registered Stock Connect fund that contains HK stock in its name to ensure that at least 80% of noncash assets are being allocated to Hong Kong-listed stocks. Given the existing robust mutual fund flow, we believe this new regulation will further solidify the structural allocation coming from the southbound channel. Investment Insights: Southbound liquidity is a structural positive for H-shares + 3

4 Conclusion Robust southbound flows reflect a structural allocation to H-shares+. We believe these flows are here to stay, with rising participation from mainland Chinese insurance and other institutional investors, who are in search of unique investment opportunities not offered elsewhere. The southbound flows coming from mainland Chinese investors are clearly creating much more liquidity than many may have imagined. We believe global investors investing in Chinese equities can also benefit from the additional liquidity and the gradual broadening of the investor base in the Hong Kong stock market. 1 H-shares are defined by the Hong Kong Stock Exchange as companies that are incorporated in mainland China and whose listings in Hong Kong are approved by the China Securities Regulatory Commission (CSRC). This group of companies forms an integral part of the offshore Chinese equities listed in Hong Kong. In this paper, H-shares+ refers to a broader definition that includes H-shares, red chips and other Hong Konglisted Chinese companies.the MSCI China Index captures large and mid cap representation across China H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 150 constituents, the index covers about 85% of this China equity universe. 2 Despite the MSCI China Index A-share inclusion scheduled to happen in 18, the MSCI China Index currently does not contain any A-shares. 3 Source: Goldman Sachs, year-to-date data as of Sept. 27, Source: Goldman Sachs research, data as of Sept. 28, 17 5 Sources: Goldman Sachs Research, Bloomberg, Factset, CEIC, market cap data as of Sept. 27, 17 6 Sources: Goldman Sachs Research, Bloomberg, Factset, CEIC, market cap data as of Sept. 27, 17 7 Sources: Morningstar, Invesco. Hang Seng Total Return Index year-to-date Sept. 30, 17 returns expressed in US dollars. 8 Sources: Bloomberg, EPFR, FactSet, Goldman Sachs Research, data as of Sept. 27, 17 9 Sources: HKEX Fact Book 15 and HKEX cash market transaction survey 16, published in July Source: UBS research, published in July Source: CICC research, as of Sept. 29, 17 Investment Insights: Southbound liquidity is a structural positive for H-shares + 4

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