Taking stock

What we lack is relatively long-term, rational investment from institutions,” complained Qi Bin, head of the international department at the China Securities Regulatory Commission (CSRC). He was commenting shortly after the launch of the Shanghai-Hong Kong Stock Connect scheme in November last year. Sadly, 2015 won’t be remembered as one in which institutional investors finally introduced more sophisticated valuation techniques to China’s A-share market, as the founders of Stock Connect hoped.

Charles Li, head of Hong Kong Exchanges and Clearing (HKEx) and Gui Minjie, President of the Shanghai Stock Exchange, had plotted this goal when they first discussed a mutual access scheme at a small teahouse in Shenzhen in 2012.

They hoped that a link between their respective exchanges would help tilt the Chinese stock market away from momentum-driven retail investors towards the kind of funds that dominate Hong Kong trading, where roughly 60% of business is driven by institutions (and 80% of that by foreign funds).

Instead, 2015 will be remembered as the year when foreign investors weren’t able to provide a sobering influence as millions of retail investors got drunk on spiralling share prices and margin financing.

As a result, many of the press articles marking Stock Connect’s one-year anniversary on November 17 have been downbeat.

“The Chinese government hoped Hong Kong’s professional fund managers would buffer the A-share army, but that hasn’t happened as anticipated,” reported National Business Daily, with some understatement.

Daiwa’s strategist Kevin Lai went further, telling the Wall Street Journal that the scheme has “failed miserably”. Figures show that northbound investors (from Hong Kong to Shanghai) used up only 40.3% of their annual Rmb300 billion ($46.95 billion) quota. Southbound investors used up less: 36.72% of their Rmb250 billion allowance.

Of course, Stock Connect was launched only shortly before the height of China’s stock market frenzy this spring, when Shanghai and Shenzhen were trading up to $380 billion a day, compared to about $9 billion in London and $248 billion across the US. Foreign investors then had to deal with the disorderly consequences of the subsequent meltdown, with many of them running rapidly for the exits.

HKEx’s Li argues that the market needs to take a longer-term perspective. “The focus shouldn’t be on aggregate quota usage or trading turnover,” he told Xinhua. “Stock Connect is much bigger than that. It’s a catalyst and a model for the future.”

But wider analysis of the scheme shows that foreign and domestic retail investors have displayed very different criteria in utilising the cross-border link. Foreign money has favoured (available) large cap stocks in China with valuations below 30 times earnings and a track record of paying dividends. Their top holdings are in banks and durable consumer goods. Mainland investors, on the other hand, have preferred small cap stocks in pharma, construction and property. This may bode well for smaller firms listed in Hong Kong if the Shenzhen-Hong Kong Stock Connect also gets off the ground, as it will embrace Hong Kong’s Small Cap Index.

When might that be? The People’s Bank of China tripped up a few weeks ago when it republished old comments mentioning that the Shenzhen link could start before the end of 2015 (sparking a short-lived rally). But analysts believe that any expansion in Stock Connect is more likely in spring next year, so that China stands a better chance of getting its A-shares included in the MSCI’s Emerging Market Index.

CSRC officials have also hinted that Stock Connect’s quotas and list of investable stocks will be expanded, allowing investors to trade across the wider market. Further down the road, bourses in London, Taipei and New York’s Nasdaq are hoping to set up similar two-way schemes too.

This might help to stem the flow of Chinese firms delisting from the US, including property portal SouFun, which is about to become the first NYSE-listed Chinese company to hive off assets and refloat them in China via a backdoor listing.

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