Foreign investors shun A shares
Mark O'Neill in Shanghai
QFII scheme finds their money heading into bonds instead
Less than half of the foreign money channelled through China's qualified foreign institutional investor (QFII) scheme introduced last year has gone into domestic A shares, as investors have found few compelling stocks to buy.
Investors are instead parking their funds in bonds or simply leaving the money in the bank, waiting for equity market performance to improve and the potential fillip of a yuan appreciation.
The QFII scheme was launched at the end of May last year by the China Securities Regulatory Commission, which said the introduction of foreign capital would help stabilise China's roller-coaster equity markets by bringing in international financial management practices.
The CSRC has approved 15 investors, with an allocation of US$1.8 billion.
But the profit is in the future, not the present. A slow market, company scandals, an overhang of non-tradeable state shares, poor transparency and corporate governance, and a weak legal system have discouraged investors, who prefer their Chinese shares from Hong Kong, New York or London.
'The importance of QFII is more symbolic than real,' said an analyst at one QFII company. 'It will take at least five years for QFII to have an impact on the market.'
The State Administration for Foreign Exchange (Safe) said in May that of the 14 billion yuan quota at the end of March, only 8.8 billion yuan, or 63 per cent, had been invested in securities. The remaining 5.2 billion was lodged in banks. Brokers estimate that less than seven billion yuan was in stocks, far less than the Chinese regulators had hoped for.
Many investors are approaching the stock market indirectly through corporate convertible bonds. For example, last December UBS bought two billion yuan worth of convertible bonds issued by Capital Steel. Citigroup Global Markets recently bought 70 million yuan of convertible bonds from paper producer Anhui Shanying Paper Industry.
'Convertible bonds in China have a special feature in that most of them are guaranteed by banks, which removes a lot of the risk,' said Nicole Yuen, head of China Securities at UBS.
'They offer a cheap, easy way for investors to buy into otherwise expensive equity.'
Other investors prefer to play it even safer.
On May 28, a Safe official criticised the institutions for channelling money into low-yield bank accounts, implying that the real purpose was to speculate on the revaluation of the yuan.
'If we discover that their purpose, of keeping the money in the banks long term, is speculative, we will not sit on our hands but take measures to restrict them, even to the point of telling them to withdraw from the QFII scheme,' the official said.
While Safe believes the flow of funds into bank accounts reflects currency speculation, another reason could be the difficulty QFII investors face finding good stocks to buy in a market that has languished for most of the past year, despite China's roaring economy.
Even Ms Yuen, a bullish proponent of QFII, admits it is hard to pick suitable buys.
'Only a few of the 1,300 listed firms meet our four criteria - high liquidity, strong profit potential, transparent management and a reasonable price,' she said.
'If the price falls, we analyse,' she said. 'If it is due to a macroeconomic reason, we hold on. But, if it is due to a problem in the stock, we sell at once. We like ports and infrastructure companies and are waiting to see the impact of macroeconomic policies on the sectors. Our optimism is based not on a short-term recovery of the market but on the long-term development,' Ms Yuen said.
UBS earlier this year applied to regulators for an additional QFII quota of US$200 million, but this has yet to be approved.
'Our allocation of US$600 million is fully invested and we have many clients who want to invest more,' she said.
There are other reasons for caution - the CSRC sets an ownership limit of 10 per cent on individual stocks for any single foreign investor, making it difficult to influence the price and giving them almost no say in corporate governance.
The QFII allocation is a fraction of the four trillion yuan capitalisation of the A-share market. There is also an overhang of state shares, which account for 60 per cent to 70 per cent of most listed companies. It is not known when Beijing will allow them to be traded or what their effect will be on the market when they are unloaded.
Despite these obstacles, institutions with QFII quotas are investing in larger research teams and qualified personnel in anticipation of a bigger allocation in the future and more interest from their clients.
No one expects Safe to act on its threat and order an investor to pull out, since Beijing wants more foreign capital in the market.
'The CSRC wants more international investors,' said the QFII analyst. 'More houses are applying for quotas. In the long term, there will be more and more foreign money coming in.'