The progressive measures enforced to expand the Shanghai-Hong Kong Stock Connect program should continue to provide enhanced liquidity and opportunities, experts believe. Lam Yik Fei / Bloomberg

Fund managers chase handsome profits from cheap share buys in city

Mainland fund managers are pouring more money into the Hong Kong stock market to seek arbitrage opportunities arising from the massive valuation gap between Hong Kong and Shanghai-listed companies.

They see more funds flowing into the Hong Kong bourse, which saw records tumble last week. Among stocks, they are going after small or medium-cap shares.

"Compared with those in the A-share market, the prices of many growing small- or medium-cap stocks are much lower in the Hong Kong market," said a researcher with a Shanghai-based public funds firm.

Late last month, the central government gave the green light for mainland mutual funds to invest in Hong Kong stocks under the Shanghai-Hong Kong Stock Connect program.

"The good news from the central government, coupled with the huge value gap, has given rise to new arbitrage opportunities," the researcher said, adding that mainland money will continue to flow into the SAR if shares in the mainland market remain expensive.

According to HSBC statistics, about 40 percent of Shanghai-listed enterprises have price-to-book (PB) ratios in the range of 1X-3X. For Shenzhen-listed companies, that range increases to 5X-10X. By contrast, nearly 40 percent of Hong Kong companies have a PB below 1X, with 32 percent having a PB of 1X-2X. A low PB suggests that a stock is undervalued.

H shares also tend to perform better on a price-to-earnings (PE) basis. According to media reports, the CSI 300 has risen from 8.11X to 15.6X since March last year, while H shares have gone from 6.3X to 9.33X, which is still relatively cheap.

"With cheap valuation, strong cross-border liquidity and a positive technical setup, Hong Kong is entering a bull market," said Hong Hao, chief strategist with BOCOM International.

The benchmark Hang Seng Index (HSI), which has soared 12 percent in the past two weeks, surpassed the 28,000-point mark for the first time in more than seven years on Monday. Gains were pared down on Tuesday, with the HSI slipping 1.6 percent to close at 27,561.5.

The mainland's CSI 300 Index has soared more than 90 percent in the past year, while the Hang Seng China Enterprises Index has risen by around 30 percent.

"There's still a 23-percent gap in A-H share valuations, while H shares are trading at a 61-percent discount in 84 dual-listed companies. This means that Hong Kong-listed stocks remain relatively attractively valued versus the onshore market," said Mandy Chan, head of mainland and Hong Kong equities with HSBC Global Asset Management.

The premium mainland market shares have over their Hong Kong-listed peers has fallen sharply in the past week on signs of increasing demand for Hong Kong shares, raising expectations of arbitrage opportunities from fund managers.

Chen Zhizhong, a Shenzhen-based analyst at China Merchant Securities, said analysts had been pondering over whether the time was right to move into Hong Kong. The consensus was a big "yes".

HSBC's Chan said they see an unjustified valuation gap between Hong Kong-listed small-cap stocks and their A-share counterparts. There are a total of about 44 Hong Kong-listed, small-cap stocks eligible for southbound investments, trading at an average of 10X PE in 2014, compared with an average PE of 26X for their northbound counterparts, many of which are in similar sectors.

"That these stocks offer mainland investors better value than the expensive A shares is a no brainer, so it's only a matter of time before we see these stocks picking up," she said.

After the China Securities Regulatory Commission gave mainland mutual funds approval to invest in Hong Kong stocks via the Shanghai-Hong Kong cross-trading link, huge mainland funds have poured into the Hong Kong bourse.

The Shanghai-Hong Kong program saw record turnover last week and, for the first time, mainland investors used up their entire daily quota under the program last Wednesday. Among the most actively traded stocks on Hong Kong's main board were GOME Electrical Appliances Holding Ltd, up 22.7 percent to HK$2.49, Ping Shan Tea Group Ltd, up 4.2 percent to HK$0.05 and Semiconductor Manufacturing International Corp, down 1.1 percent to HK$0.92.

"We are in the midst of a profound structural change - the gradual but accelerating opening up of the mainland's financial markets," said Hong Kong Exchanges and Clearing Ltd Chief Executive Charles Li Xiaojia.

"Our securities market provides a good investment outlet for mainland funds and is an excellent way for mainland investors to diversify their portfolios," he said.

On Monday, investors were also encouraged by a Hong Kong media report that the daily quota for Hong Kong stock purchases by mainland investors under the Stock Connect would be quadrupled to 40 billion yuan ($6.4 billion).

"The progressive measures enforced to expand the Shanghai-Hong Kong Stock Connect program should continue to provide enhanced liquidity and opportunities," said HSBC's Chan.

"The upcoming launch of the anticipated Shenzhen-Hong Kong Stock Connect program later this year could serve as another catalyst for Hong Kong-listed small caps to go forward," she added.

However, analysts have warned of potential risks with the fear of a rerun of the euphoric boom and bust of 2007, when a previous "through-train" plan was announced but later shelved, pointing out that the mechanisms between the mainland and Hong Kong stock markets differ.

There is no mechanism to limit a stock-price fall of 10 percent in Hong Kong. In addition, individual shares can be shorted, which investors should also be careful about, said the researcher from the Shanghai-based public fund.

Reuters contributed to the story.

zhouwa@chinadaily.com.cn

(HK Edition 04/15/2015 page9)