Harvey Jones
05.04.2023

Investors can’t afford to overlook mainland China A-Shares any longer
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We may be in the Year of the Dragon, according to the Chinese lunar calendar, but the country’s three major stock markets have lost their roar.
A staggering $6.1 trillion have been wiped off Chinese share values in the last two years, while the $300billion collapse of property giant Evergrande Group has spooked global investors.
Yet recent setbacks could present an exciting buying opportunity as the bad news is now priced in and shares look cheap, says Rebecca Jiang, portfolio manager of JPMorgan China Growth & Income. “We remain optimistic about China’s long-term prospects.”
Sophie Earnshaw, co-portfolio manager of Baillie Gifford China Growth, says China cannot be ignored. “The country remains unique in the size of its markets and the scale of the opportunities it offers.”
So far, most international investors have bought shares listed in on the Hong Kong Stock Market, but it's getting easier to buy mainland shares listed in Shanghai and Shenzhen, too.
They may be riskier, but also more rewarding.

Mainland shares go mainstream

Most international investors purchase H-shares listed on the offshore Hong Kong Stock Exchange, which are freely traded in Hong Kong dollars, and follow international accounting and reporting standards. It’s a simpler, safer way to invest.
Chinese A-shares are traded on the onshore Shanghai and Shenzhen exchanges, and quoted in Chinese yuan renminbi. Initially restricted to domestic Chinese investors, international investors can now access them, too.
A-shares offer global investors access to a vast new pool of Chinese companies, with 2,263 stocks listed in Shanghai and 2,844 in Shenzhen. That's on top of the 2,609 listed in Hong Kong.
They give investors exposure to exciting domestic consumer trends such as artificial intelligence, healthcare and green technology, where China is increasingly leading the way, especially in the electric vehicle (EV) sector. Last year, 31 per cent of all domestic new car sales were EVs, according to the China Association of Automobile Manufacturers (CAAM), and sales are expected to top 50 per cent by 2026.
Domestic manufacturers such as NIO and BYD account for 60 per cent of global EV production and export more than half a million cars a year. Mainland-listed shares also give investors greater exposure to Chinese small and mid-cap stocks that typically service the domestic economy.
As well as faster growth prospects, they are sheltered from US-China tensions, and Chinese regulatory interventions that have hit companies like mega-cap tech giants Alibaba and Tencent Holdings, both listed in Hong Kong.
Shao Ping Guan, senior portfolio manager of the China A Shares and All China Equity strategies at Allianz Global Investors, says investing in a combination of H-shares and A-shares gives investors a proper balance between old and new economy stocks. “This offers a true representation of China’s potential.”

Time to Connect?

Foreign investors only own around 7.3 per cent of the total A-share free float market, according to UBS, but that is steadily changing.
In 2014, Beijing launched the Shanghai-Hong Kong Stock Connect programme, followed by the Shenzhen version in 2016.
This makes it easier for mainland Chinese investors to purchase select H-shares. It also allows foreigners to invest in 3,623 A-shares via their brokerage or trading platform, with transactions conducted in renminbi rather than Hong Kong dollars.
In 2018, MSCI started to partially include large-cap Chinese mainland stocks in its Emerging Markets Index, initially with a 5 per cent weighting.
It reckons they’re too big to ignore and combined with H-shares, provide a more complete and representative proxy for Chinese GDP.
If fully included, Chinese A-shares would exceed 40 per cent of the entire MSCI Emerging Markets Index, which demonstrates their sheer scale.

Divergence opportunity

Around 150 of the largest and most liquid Chinese mainland companies have a dual-listing in Hong Kong. Intriguingly, their onshore and offshore share valuations diverge, often dramatically, as they attract different investors and there is no convertibility.
This divergence is measured by the Hang Seng Stock Connect China AH Premium Index. At time of writing, this is currently trading at around 153, which indicates that A-shares are 53 per cent more expensive than their H-share equivalents.
Five years ago, the index stood at around 118. The valuation gap has widened as A-share valuations rise at a faster pace.
It could widen further as Beijing looks to beef up the ailing domestic stock market after a dismal 2023, via its 2 trillion yuan ($278 billion) rescue package.
State-owned Central Huijin Investments has been increasing its stake in China’s Big Four banks, while another state-run enterprise, China Reform Holdings, is buying up domestic exchange traded funds (ETFs).
This triggered a rally in February and is expected to drive up the A-share premium even higher this year, giving investors superior potential returns.

Risks and rewards

Mr Ping Guan says “dispersion" between the two markets presents opportunities and where possible, the Allianz All China Equity fund invests in the cheaper share class of a dual-listed company.
“This reflects our view that over the long term, there will likely be gradual convergence between onshore and offshore markets in China. That said, we do not see this being arbitraged away easily in the short-term,” he says.
The historical correlation between China A and China H is only 0.59, Mr Ping Guan says, which means that 59 per cent of the time these two markets have moved in different directions. “This divergence has been declining over time, suggesting that markets have become more synchronised, but are by no means in lock step.”
Inevitably, there are risks. Chinese onshore markets remain isolated, with capital movements restricted while the renminbi is still not fully convertible.
There is also a small tax advantage to buying H-shares, as Hong Kong does not impose a withholding tax on dividends and interest, while A-shares incur a 10 per cent charge. Investors also face risks such as weaker corporate governance, less transparency and greater volatility.
Most private investors will spread their risk with an ETF or two.

Funds to use

The iShares Core Hang Seng Index ETF focuses purely on Hong Kong-listed shares, as does the Xtrackers FTSE China 50 UCITS ETF.
The iShares MSCI China A ETF provides pure access to A-Shares. Xtrackers Harvest CSI 300 China A-Shares ETF and JPMorgan’s China A Research Enhanced Index Equity (ESG) UCITS ETF are also options.
Some funds invest in both categories, notably the Fidelity China Special Situations Trust and Xtrackers MSCI China UCITS ETF.
Some ETFs also target Chinese B-Shares, a third category of stock traded in Shanghai and Shenzhen, but settled in US or Hong Kong dollars.
After recent struggles, many investors will avoid China altogether. Those who are keen now have an exciting new way to ride the dragon's tail.

Harvey Jones has been a UK financial journalist for more than 30 years, writing regularly for a host of UK titles including The Times, Sunday Times, The Independent and Financial Times. He is currently the personal finance editor of the Daily Express and Sunday Express, and writes regularly for The Observer and Guardian Unlimited, Motley Fool and Reader’s Digest.

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