Mark Williams

Connect 2 - Investing in Chinese equities

Mark Williams

The two most prominent means of investing in Chinese companies are A shares and H shares.

 

A shares are company shares that are traded on China’s mainland stock exchanges in Shanghai and Shenzhen. These stockmarkets opened in 1990 and for many years were only accessible to domestic investors.

 

Since the opening of the Shanghai and Shenzhen markets, the Chinese have emphatically embraced equity investing. Around 200 million Chinese retail investors own the majority of A shares and account for over 80% of their trading volumes.

An alternative was a different class of shares called B shares, which were available to foreign investors. The limited number of companies and liquidity in the shares meant that these never gained traction with international investors. They are still in existence but have little liquidity.

H shares are shares in Hong Kong-listed companies that are incorporated in mainland China. These are traded on the Hong Kong Stock Exchange and have been available since 1993. Tsingtao Brewery was the first, and now there are over 200.

With A share ownership initially restricted to ‘Qualified Foreign Institutional Investors’ – and this only available since 2002 – international investors for many years relied heavily on H shares in order to achieve Chinese equity exposure.

More recently, the scope for overseas investors to buy mainland China’s A-shares has been greatly increased following the introduction of ‘Stock Connects’ between Hong Kong and the mainland. The Shanghai-HK Stock Connect opened in November 2014 and the Shenzhen-HK Stock Connect followed in 2016.

These Stock Connects allow for mutual market access between investors on the mainland and Hong Kong, up to a daily value quotas for the ‘northbound’ (Hong Kong-to-China) and ‘southbound’ (China-to-Hong Kong) channels.

A number of companies have dual-listings of both mainland-listed A shares and Hong-Kong-listed H shares. Although these shares are equivalent, they have not historically traded at the same price. Shares cannot be transferred between markets so there is no scope to arbitrage significant price differences, limiting the forces that drive prices to parity.

A shares have historically traded at a premium to the equivalent H shares. Investor profile is part of the reason for this; the domestic Chinese investors who dominate A share trading on the mainland markets have few alternatives in which to invest their money. Combined with the ability to trade on margin, the Shanghai and Shenzhen A share markets can suffer dislocations from their underlying fundamentals.

Premium of A shares over H shares

The A share premium over H shares is unsurprising if we compare the average price/earnings valuations of stocks on Shanghai and Shenzhen markets – 15 and 36 respectively – with 8.2 for an index of Hong Kong-listed H shares (the Hang Seng China Enterprises Index).

To-date, the valuation premium of A shares has prevented us from adding any of these shares to the Liontrust Asia Income Fund. We have preferred to gain similar economic exposure to the mainlined using the cheaper Hong Kong-listed H shares.

But as the Stock Connect quotas rise we believe that Chinese investors will increasingly compare their domestic share valuations with those available internationally via the various Connect mechanisms. Equally, international investors will raise scrutiny of A share valuations as investment becomes easier. Combined with reduced government intervention in the mainland markets, this should allow fundamentals to increasingly assert themselves. If this results in a gradual deflation of the A share premium, then we stand ready to identify A share opportunities for the Liontrust Asia Income Fund.

The introduction and growth of the Shanghai and Shenzhen Stock Connects has been key in improving accessibility for international investors in Chinese equities in recent years. Accessibility looks set to only increase further – both for international investors looking to buy domestic Chinese A shares, and for those on the mainland investing outside of China. Quotas for the two connects between mainland China and Hong Kong will be increased, while in 2019 the London Stock Exchange launched a Shanghai-London Stock Connect. This cross-listing mechanism allows international investors to buy A shares via the London market and London-listed companies to access Chinese investors.

Index compiler MSCI has also helped propel a cycle of increased accessibility and investment by gradually raising the proportion of A shares it includes in its regional and emerging market indices as accessibility improves. As the MSCI A share allocation increases, more international investment will be directed to A shares; and this in turn will encourage more open capital markets and motivate MSCI to further increase its A share weighting.

For a comprehensive list of common financial words and terms, see our glossary here.




Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Asia team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. 

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, October 31, 2019, 11:27 AM