As Hong Kong, China Equities Converge, Investors Must Get More Choosy - BlackRock

Tom Burroughes

29 April 2015

Investors must pick their shots carefully in seeking value after the recent surge of activity – and closing of valuation gaps – between mainland China “A” shares and Hong Kong’s “H” shares, BlackRock said in a recent note.

While it took several weeks to catch fire after the Hong Kong/Shanghai Stock Connect equity market link went live late last year, recent surging volumes and sharp price action have stirred further interest in trading these markets.

“As structural reforms continue to reduce the tail risks in the economy and Hong Kong market turnover improves, we expect to see the large-cap premiums dissipate. Indeed, in the A-share market, small- and mid-caps tend to trade at noticeable premiums across most sectors,” Helen Zhu, head of China equities, , said in note.

“Some H-share sectors where we still see good value even after the recent run-up include mid-cap banks, property, utilities/new energy, while areas like construction, capital goods, transport and energy have moved to less attractive valuations largely due to the A-H price gap issue. We would be selective and continuously flexible looking forward, in terms of sector picking and choosing between A and H share investment opportunities,” she continued.

Zhu notes that the China A-share market, which has nearly doubled in the last 12 months, recorded daily turnover of $290 billion while the Hong Kong market rose by more than 30 per cent since March 2014. The latter reached its own record of $37 billion daily turnover recently.

Structural reforms have boosted returns, but the rally alone is not enough to explain the rise in trading volumes, she says. What has been a big benefit, she said, is the recent announcement by Chinese authorities to let domestic funds invest in the Hong Kong market through the Mutual Market Access Scheme.

Zhu said investors have focused on price mismatches between the A- and H-share markets – those discrepancies are partly driven by structural and liquidity factors. As a result, premiums between the shares have narrowed significantly in recent weeks, with some H-shares moving to levels that look excessive compared with their A-share regional and global peers, she said.

“We prefer to be more selective and focus on those where we think valuations are still attractive on an absolute basis and relative to regional and global peers (rather than buying on the basis of valuation relative to A-shares only). Some of these opportunities may lie in the less obvious areas e.g. not the A-H dual listed space necessarily,” Zhu said.

“Given the huge gap between A-share turnover and velocity versus H-share, we think the improving H-share turnover is the ‘new normal’ as more A-share funds flow south. In the past three-to-five years, despite some small- and mid-caps offering better growth than their large-cap counterparts, they have seen discounted valuations due to lower liquidity and greater risk."