Financial liberalisation has taken many forms. Deregulation of interest rates and new licences for domestic and foreign investors began to open up its capital markets.
More recently, in January 2015, reforms introducing the Hong Kong Shanghai Connect scheme allow the cross traffic of investments between Shanghai and the Hong Kong market, which hypothetically would decrease the big gaps in valuations between the A-share and H-share markets.
Despite this move, at the end of the first quarter of 2015, the A-share market had reached a 35% premium to the H-shares, boosted by onshore retail investors who were deterred from property investment and opaque wealth management products, and instead have invested in stocks.
Lower interest rates were the fuel to break a five-year equity bear market, driving the Shanghai A-share market up by 77% over one year (to Q1 2015), leaving H-shares with a lesser 22% advance.
Mainland retail investors have rushed to open trading accounts – 1.68 million in just one week recently. The once cheap A-share index P/E ratio has jumped to 21x, leaving an attractively priced H-share at 11x.
It is even more attractive for small-cap investors: A-share small caps are valued at PE 90x, while equivalent H-share small caps are only valued at PE 12x.
Further measures by the China Securities Regulatory Commission to encourage local mutual funds to buy Hong Kong stocks at the end of March, together with the China Insurance Regulatory Commission expanding insurers’ investment scope to include Hong Kong markets, have added more impetus.
Going the distance
Further measures will make a difference.
The Shenzhen-Hong Kong Connect scheme is due to be launched in the summer, which will support the continued H-share rebalancing. The admission of US ADR listed Chinese stocks to the Chinese and emerging market indices will provide support to the Chinese stock market later in the year.
Despite the Chinese equity market rally, long-term opportunities are plentiful; we are selecting companies with good visibility in earnings, and good free cash flow yield.
There are also opportunities in companies benefiting from government reform policies in mainland China, such as anti-pollution. We prefer the H-shares as an index investment given its potential to rise further closing the gap of the discount to A-shares.
Zhengzhou Yutong Bus is the largest bus manufacturer worldwide, with a 12% market share globally and a 30% market share in China and should benefit from these positive regulatory developments for ‘clean vehicles’ as it owns 37% of the market share for hybrid and electric buses in the country. Moreover, its strong growth is combined with an attractive pay-out for shareholders.
Shanghai International Airport, which operates the major international and national aviation hub Pudong Airport is among the fastest-growing airports globally, and passenger traffic is expected to double by 2021. It is attractively-valued compared with its peers and has positive cashflows.
The Government’s response to this potential bubble?
As we have seen with the most recent annual economic growth figures of 7%, Beijing needs to add stimulus and it has quite openly voiced its support for rising equity markets as this supports the economy.
Despite a lower – but higher quality – growth rate in China, we expect healthier investment opportunities throughout 2015.
Central to this are political changes, comprising mainly a combination of an anti-corruption programme and structural reforms opening the economy to foreign investors. Chinese authorities are facilitating the flow of overseas investment, and the benefits of these reform measures will be long term.
Despite the challenges (the growth outlook faces global headwinds), Chinese stocks should do well compared with those of other more vulnerable economies in the emerging markets universe.
