China’s transformation over recent decades has generated some great investment opportunities. But the challenge for investors has always been how to reach them. For many years, overseas investors have been restricted to a limited selection of Chinese companies. That’s now changing. As part of the Chinese government’s drive to raise the profile of its stockmarkets and open up the country to foreign investment, restrictions are being lifted.
Another step towards China’s mainland equities
The latest development was the announcement in August that a new trading link will open between the Hong Kong stock exchange and the Shenzhen stock exchange by the end of this year. The Shenzhen-Hong Kong Stock Connect will for the first time provide foreign investors with access to around 870 stocks listed in Shenzhen. This follows on from a similar trading link that opened in November 2014 which gave investors access to companies listed on the Shanghai exchange. These moves represent a significant step towards opening up China’s vast mainland, or A-share, equity market.
The A-share market consists of almost 3,000 stocks listed in Shanghai and Shenzhen, albeit initially only a subset of each exchange is available to trade via the stock connect programmes. The combined total market cap of over US$7 trillion means the A-share market is the second largest market by market cap globally, behind the New York stock exchange and comparable to Nasdaq.
It is this sheer scale that makes these developments important to all global equity investors. Before the stock-connect programmes, access to Chinese stocks was either via companies that listed in Hong Kong, so-called H-shares, or in overseas markets such as the US. The actual opportunity set for international investors has therefore been relatively limited. The following schematic shows the different characteristics that these new markets provide relative to the H-Share market. Putting aside such ‘trivial’ matters as corporate governance practices and valuations, these markets are large, liquid and currently dominated by short-term retail investors, in short ripe for good old fashioned stock picking.
Access to ‘new China’ stocks
Two years ago there was considerable excitement about the opening of the trading link between Shanghai and Hong Kong. However, in practice when you look at flows, the Shanghai-listed A-shares proved a lot less popular than forecast. Given investors have been cautious about using the Shanghai Connect, why would they be interested in gaining access to the Shenzhen market. Well, in short, Shenzhen represents ‘new China’ whereas Shanghai is dominated by what might be called ‘old China’ sectors.
Over 60% of the companies listed in Shenzhen are technology companies, consumer goods and healthcare businesses – the new areas of growth in China. Contrast that to Shanghai where over 60% of the companies are what are referred to as State Owned Enterprises (SOEs) – companies that are majority-owned by the Chinese government.
Irrespective of one’s view on the A-Share market and the challenges or opportunities that it offers, the gradual opening up of the country’s markets to international investors has long-term ramifications. China already accounts for about 25% of the MSCI emerging markets index and when fully integrated could be pushing 50%.
Faced with such a skewed index you will see a response from both the index providers and fund management houses. Expect to see a raft of China fund launches accompanied by Asia ex China and global emerging markets ex China products.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.