Across The Border

Funds stay on sidelines despite green light to participate in stock connect scheme

Announcement last year saw Hong Kong’s daily trading value hit a record HK$293.9 billion

PUBLISHED : Thursday, 21 April, 2016, 11:29am
UPDATED : Thursday, 21 April, 2016, 11:29am

So much for the high hopes and hoopla over a potential flood of funds into Hong Kong stocks after the mainland’s securities regulator lifted a ban on mutual funds’ purchases of H shares via the Shanghai-Hong Kong Stock Connect scheme a year ago.

The liberalisation turned out to be yet another damp squib after initial enthusiasm sparked a strong rally and record daily turnover in Hong Kong.

Mainland retail investors’ lukewarm interest in H shares, a lack of experience in handling equity investment overseas, and a gag order by regulators to play down fears of yuan depreciation had dampened hopes for massive capital flows into H shares, fund managers and analysts said.

In March last year, the China Securities Regulatory Commission (CSRC) allowed mainland fund houses to participate in the stock connect programme, a cross-border trading mechanism that allows investors in Shanghai to buy shares traded on the Hong Kong stock market and vice versa.

It’s obvious that mutual funds have yet to allocate a large portion of capital to the Hong Kong market
Wu Kan, Shanshan Finance

The announcement gave H shares a shot in the arm, with daily trading value hitting a record high of HK$293.9 billion on April 9 last year.

In that month, average daily turnover reached HK$200 billion, more than double the present level.

As of Wednesday, only half of the scheme’s 250 billion yuan quota for southbound trading – mainland investors buying H shares – had been used.

“Overall, the market saw lukewarm interest in Hong Kong shares,” said Wu Kan, head of equity trading at Shanghai-based investment firm Shanshan Finance. “Factoring out the purchase of H shares by retail investors and hedge funds, it’s obvious that mutual funds have yet to allocate a large portion of capital to the Hong Kong market.”

Eighteen mainland mutual fund products have been issued to raise money from investors to buy H shares through the stock connect scheme.

But the first three funds saw assets under management shrink by about 44 per cent between April and the end of last year. The loss of net asset value was the result of both unsuccessful operations in the Hong Kong market and huge net redemptions.

Giving mutual funds permission to trade shares via the scheme had been regarded as a substantial move that was likely to result in larger capital outflows from the mainland.

Mainland mutual funds had received a combined US$28.8 billion quota under the qualified domestic institutional investor (QDII) scheme by the end of 2015.

Stock Connect scheme has faced low turnover, volatility and regulatory challenges

QDII investors raise yuan funds from mainland investors before converting them into foreign currencies for equity purchases outside the mainland.

The stock connect scheme’s total southbound quota of 250 billion yuan could technically have cleared the way for mutual funds to substantially boost their asset allocation in Hong Kong-listed shares.

In 2007, rumours of an imminent “through train” scheme that would have allowed retail investors on the mainland to directly buy shares in Hong Kong led to a strong rally in Hong Kong but the scheme never eventuated, with Beijing scrapping the plan due to fears it might trigger a huge capital outflow that could cripple the domestic A-share market.

Fund managers said the boom-to-bust run on the A-share market last year that wiped out more than US$5 trillion of market capitalisation between mid-June and late August had not necessarily dented investors’ buying interest.

Mainland investors are the most cynical in Asia about equity investments, with nearly 80 per cent of them regarding share trading as having the same kind of odds as gambling, a survey by US asset manager Legg Mason and Citibank showed.

Yet they are bullish about the A-share market’s outlook this year, with a median forecast of a 12.4 per cent rise, the survey of 200 wealthy mainland investors found.

“Mainland investors are expecting to buy low following a sharp fall in the past 10 months,” said Ivan Shi, head of research at fund consultancy Z-Ben Advisors. “The majority of the funds are still targeted at A shares.”

Two fund managers said a lack of experience in trading H shares had also deterred mainland fund houses from aggressively expanding business amid the liberalisation brought on by the stock connect scheme.

Weak yuan spurs surge in southbound Shanghai-Hong Kong stock connect trade

They added that confusion over the authorities’ stance on the yuan’s exchange rate had also resulted in lacklustre fundraising for H-share investment.

The mainland’s financial authorities, battered by fears of massive fund outflows due to a weakening currency, halted a series of planned liberalisations including the introduction of a second phase of the qualified domestic individual investor scheme (QDII2) scheme that could have led to an acceleration in capital flight.

They also ordered mutual funds to not use yuan devaluation as a reason to promote sales of funds earmarked for foreign investment.

“The gag order did play a role in the fund companies’ decision making,” a fund manager in Shanghai said. “It’s safer to wait and see. After all, you can’t avoid mentioning yuan depreciation when promoting the sale of the funds.”