Shenzhen-Hong Kong stock connect could see muted response
High valuations and vague corporate governance standards look set to dampen foreign institutional investor interest in mainland shares
Foreign institutional investors may be apprehensive about picking up China's high-growth shares in the Shenzhen-Hong Kong stock trading scheme, given high valuations and vague corporate governance standards.
Shenzhen Stock Exchange general manager Song Liping announced that shares on the country's ChiNext board were likely to be included in the trading link with the Hong Kong board, which is expected to kick off in the second half of this year.
"The valuations of many stocks on ChiNext have risen to up to 100 times price-earnings, driven by speculators, [and] we see substantial risks," said Kathy Xu, a fund manager at Aberdeen International, which helps manage US$6.2 billion worth of assets in a China-related portfolio.
The quota-based trading link is a natural expansion of the Shanghai-Hong Kong Stock Connect, which was launched in November last year, but expectations have been building that some improvements should be made to encourage more users, especially institutional investors, to use the scheme.
The average volume of the Shanghai-Hong Kong trading link has been weak since its launch.
In the four months to the end of last month, the northbound trade volume averaged 5.2 billion yuan a day, accounting for just 40 per cent of the permitted quota.
The southbound flow averaged 900 million yuan, only 8.6 per cent of the cap, according to Hong Kong stock exchange data.
Some mid and small-sized companies in the Hong Kong market have been undervalued
The tepid response from global managers to the Shanghai-Hong Kong link was a result of concern over the mainland's economic slowdown and, more importantly, a lack of confidence in its corporate governance among foreign asset managers.
All the shares bought by foreign investors through the link are owned by China Securities Depository and Clearing Corp rather than by the investors themselves. That has made big houses reluctant to invest in the scheme due to company compliance issues.
As for the southbound trade, mainland investors tend to favour small-cap stocks rather than blue chips, but most of their targets were not included in the Shanghai trading link.
Many punters believe improvements should be made to this part of the scheme to attract more users.
Some analysts argue that more stocks should be added to the new trading link. That may include some mainland B shares and mid and small-cap stocks in Hong Kong, which may be appealing to some investors.
"Some mid and small-sized companies in the Hong Kong market have been undervalued. Those stocks have a dividend payout ratio between 70 and 80 per cent and have more upside than A shares," Xu said.
"The stock connect in the long term will help improve the corporate governance of all Chinese companies.
"It has been the retail investors that are driving the market, so many listed companies tend to do some short-sighted management to excite the market, which is not healthy in our view."
Another expectation is that the mainland's B shares should be incorporated so they can be traded as well.
B shares can be traded by onshore and offshore investors using foreign currencies. Many are trading at huge discounts to their A-share peers, thanks to the small trading volume.
"B shares such as Changan Auto are a forgotten asset class that will ultimately be fungible into A shares once both the Shanghai and Shenzhen links are connected with Hong Kong," said Jefferies analysts led by Sean Darby.
