Chinese investor flows into Hong Kong equities via the Stock Connect trading link have accelerated in the past two months, amid rising demand for overseas exposure and a weakening renminbi.
This trend is thought to be driven above all by mainland asset managers and insurance firms, and likely also reflects foreign investors’ preference for H-shares and reluctance to buy mainland A-shares. Moreover, H-shares are currently cheaper than Shanghai stocks.
Chinese investors poured a net Rmb59 billion ($8.8 billion) into Hong Kong shares via the southbound leg of Stock Connect in May and June alone, leaving just Rmb56 billion (22%) of the total Rmb250 billion of southbound quota available as of July 5.
That is a marked acceleration in the pace of southbound flows: it represents Rmb85.7 billion of the total used this year. There had been Rmb141.7 billion in southbound quota remaining as of end-2015.
The southbound leg will hit its quota cap in 22 trading days if Chinese investors continue to pour Rmb2.5 billion daily into Hong Kong stocks via the trading link, as they did in June.
By contrast, just Rmb12.5 billion of northbound quota has been used this year, Rmb5.5 billion of which was invested in May and June. There is Rmb164.8 billion (55%) left of the Rmb300 billion in northbound quota. This suggests foreign investors are increasingly reluctant to buy A-shares.
These flows mark a clear reversal of the initial trend, whereby northbound had outpaced southbound investment after the trading link launched in November 2014.
Demand for higher yields and foreign assets are the main drivers for southbound trading through the link, said Jessica Wu, Beijing-based equity analyst at Goldman Sachs, in a report yesterday.
Despite the limited disclosures by southbound scheme participants, Wu said she suspected both fund managers and small insurers were the key players. Onshore bonds and banks’ wealth management products are no longer able to offer the yields to match insurers’ relatively high funding costs, which are estimated at 5.8%, she added.
In respect of stocks listed in both Hong Kong and Shanghai, H-shares offered an average 6% dividend yield against 4.8% for A-shares as of the end of June, noted Wu. The higher dividend yield was also down to the lower price of Hong Kong listings, with 58 out of 70 H-shares trading at a discount of 20% or more to their A-share equivalents yesterday.
Gao Ting, Shanghai-based strategist at UBS, agreed that the southbound flows were probably driven by institutions rather than retail or speculative money.
Mainland retail investors tend to invest in high-growth and mid-to-small-cap stocks, he told AsianInvestor, whereas the top 10 Hong Kong stocks receiving southbound flows are largely high-dividend H-shares, such as Chinese banks, and blue chips, such as HSBC and internet giant Tencent.
Hong Kong stocks offer both lower valuations and offshore exposure for Chinese institutions, as the renminbi has weakened 2.9% since April 1, said Gao. The currency has fallen a total of 7.2% against the dollar since October, when the central bank started taking action to devalue it.
Mainland investors find it difficult to obtain offshore exposure, as the foreign exchange regulator has not handed out any new quota under the qualified domestic institutional investor (QDII) scheme – which allows them to buy offshore assets – since March last year.
Gao said the aggregate quota for Shanghai Connect was likely to expand, both southbound and northbound.
Meanwhile, the relatively high price of mainland shares may prove to be an obstacle to the upcoming Shenzhen Connect gaining traction, said Gao. Shenzhen-listed stocks are very expensive, with an average price-to-earnings ratio of 41.12x, versus 14.84x for Shanghai shares, as of yesterday.
Liu Shiyu, chairman of the China Securities Regulatory Commission, has reportedly said the Shenzhen Connect would be launched this year but that some technical issues still needed clarifying. He did not elaborate on what they might be.