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Hong Kong - China’s quest to clean up its financial system may be scaring some investors away from mainland shares, but for Eastspring Investments it’s the perfect time to switch strategy.
The Asian asset-management arm of Prudential, the UK’s largest insurer, is seeking out mainland consumer and property stocks after taking profit on investments in Hong Kong-traded Chinese equities.
Jitters over Beijing’s regulatory crackdown have sent the Shanghai Composite Index down more than 4% from an April peak, narrowing the mainland benchmark’s price premium over offshore Chinese shares to the least in two years this week.
“A shares, especially the larger caps listed in Shanghai, those have become much more attractive from an overall valuation standpoint,” said Ken Wong, a fund manager for Eastspring in Hong Kong. “We are actively looking at potential investments in A shares as a result of gap closure between A and H shares.”
Wong isn’t the only big investor shrugging off the regulatory measures, which are seen as part of China’s wider campaign to reduce a record leverage pile.
Mark Mobius welcomed the crackdown, saying it is “overdue.” The executive chairman of Templeton Emerging Markets also favors mainland, or A shares, over Hong Kong-listed H equities in the long term, saying A stocks will gain an edge on the back of China’s recovering economy. The legendary developing-market investor said last month that offshore-traded Chinese shares had become too expensive.
The Shanghai Composite dropped as much as 1.4% on Thursday, after a review of risk in China’s financial markets received the backing of President Xi Jinping and the Communist Party’s powerful politburo. As well as whipsawing the stock market, the flurry of initiatives from Chinese regulators this month have helped propel 10-year government bond yields to their highest level in almost two years.
Buy cheap
Chinese stocks listed in Shanghai are consistently more expensive than those in Hong Kong because officials limit new offerings and capital controls make it one of the few places domestic investors can park capital. The Shanghai Composite sank to a price-to-earnings valuation of 17.7 on April 24, making it the cheapest versus the MSCI China Index since October, data compiled by Bloomberg show.
Gains in Hong Kong-traded stocks had already narrowed the gap considerably, with the MSCI China up 17% this year, hitting a 21-month high this week. The Shanghai Composite, meanwhile, is 39 % below a peak reached in mid-2015.
“We buy wherever is cheap,” Eastspring’s Wong said. “Right now there are definitely some opportunities in some of the larger names on the A-share side.”
Utilities have led declines in Shanghai over the past two weeks, reducing the P/E premium on the Shanghai Stock Exchange Public Utility Index to the least since October versus the MSCI China Utilities Sector Index.
Industrial & Commercial Bank of China, the biggest Chinese stock traded on both the mainland and in Hong Kong, saw its Shanghai shares drop to the cheapest level relative to its Hong Kong equities in almost a month.
Mobius’ view
“From a longer-term perspective the H and A share markets should merge in behavior as the Chinese market becomes more liberalized,” Mobius said by email April 26. “In the meantime however, this is not the case and the local market is more dynamic with a greater number of investors, so we can expect A shares to outperform if the current positive economic environment holds.”
The Templeton chair’s view may seem too bullish to analysts who see increased scrutiny of China’s financial sector as a headwind for the stock market.
In a Bloomberg survey at the end of March, tightening liquidity conditions amid China’s de-leveraging campaign were cited as a reason to be cautious about mainland shares. The Shanghai Composite will end 2017 at 3 525 points, according to the median of eight analyst and fund manager targets, down from a consensus of 3 800 points in a separate survey in December.
The measure was little changed at 3 154.39 as of 08:00 time on Friday, while the MSCI China Index fell 0.2%.
Adrian Zuercher, head of Asia Pacific asset allocation at UBS’ private banking arm in Hong Kong, is also in the bulls camp. He sees Beijing’s campaign to contain risk as a good sign, as it shows officials have enough confidence in the economy to embark on some tough reforms - even if it causes some market volatility in the short term.
“In the medium- to long term A shares look pretty attractive,” said Zuercher. “You have more growth stocks in these areas - it’s more the private sector company that could start to show a lot of earnings growth. So in the long term we definitely look in to onshore China.”
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