The Shanghai-Hong Kong Stock Connect, which is expected to go live next month, could create a market so large global investors could not ignore it, argued Goldman Sachs.
The linking of the Hong Kong and Shanghai bourses to allow trading of each other's securities could be seen as creating the world’s second largest equity market with capitalisation of $6.7 trillion, said Kinger Lau, China strategist at the US bank.
Interest in A-shares is likely to be fuelled partly by investors hunting for yield amid low interest rates in the US, said Goldman Sachs, which forecast that the US Federal Reserve will not raise rates until the third quarter of next year.
A group likely to tap A-shares is asset owners with global mandates, thanks to such securities' attractiveness for various reasons.
Average equity dividend yields globally stand at 2.5%, while those for A-shares average between 2.9% and 4.2%, depending on the benchmark used, Goldman Sachs said. It attributes A-shares’ dividend premium partly to the solid growth of fundamentals and the government encouraging state-owned enterprises to boost their payouts.
A-shares are also attractive because their valuations remain at near all-time lows, said Lau. The average forward 12-month price-to-earnings ratio for the CSI 300 is 8.6 times including the country's troubled banking sector and 11.7 times excluding it. That compares with an average of 15.1 times since 2004 to date and 35 to 40 times at the index’s peak in 2007.
However, investments into China through Stock Connect will be limited, at least initially, by quotas.
A daily quota of Rmb13 billion ($2.1 billion) will be in force for northbound trades – that is, for offshore investors to trade A-shares on the Shanghai Stock Exchange. Southbound trades – mainland investors trading H-shares – will be subject to a quota of Rmb10.5 billion. The quotas, which apply only to buy orders, are applied at the exchanges.
Lau said there is a high likelihood that these quotas will be expanded, given that Beijing has a track record of incremental liberalisation.
The amount of renminbi qualified foreign institutional investor (RQFII) quota granted has risen to $70 billion from $10 billion in mid-2012, while granted QFII quota has risen to $95 billion since 2003, when the scheme was introduced.
Appetite for A-shares will grow further if and when China is included in MSCI's emerging market indices. In June last year, MSCI included China on its list for consideration in its EM index. Its proposal for inclusion would start A-shares at a 5% weighting.
The implementation of Stock Connect could allow investors to access China’s growth story more efficiently than if they invested in H-shares, said Lau, because the scheme will open up equity sectors not available offshore.
He identified 16 niche industries that may attract interest, as they are less vulnerable to swings in government policy than sectors such as steel, rail or other fixed-asset investment sectors, and because none of their constituents is listed abroad.
The list includes distillers and vintners, of which 20 are listed in Shanghai with total free-float market cap of $21.8 billion; 14 electricity utilities with total market cap of $4.7 billion; and 13 publishing companies (market cap: $7.1 billion).
Further, stocks with big QFII holdings will also probably be attractive to investors trading through Stock Connect because existing QFII holders should already have conducted bottom-up analyses on these companies. Therefore, they are likely to conform to standard investment and valuation frameworks.
Auto company SAIC Motor, alcohol group Kweichow Moutai and materials group Anhui Conch Cement fall in this category, Goldman Sachs said.