Price gap between A and H shares expected to remain, even with the arrival of Shenzhen-Hong Kong trading link
International investors trading in A shares still represent just 1 to 2 per cent of Shanghai’s turnover, while mainland investor trading represents 5 to 10 per cent of Hong Kong’s turnover
The cross-border Stock Connect trading link between Hong Kong and Shanghai has led to increased fund flow between the two stock markets – but it has yet to narrow the price gap between the shares listed on either bourse, illustrating just few investors have profited by trading in both.
And brokers believe the Shenzhen-Hong Kong Stock Connect, which goes live from Monday, December 5, is unlikely to make any difference.
While stocks such as HSBC and Standard Chartered – dual-listed in Hong Kong and London – have seen their prices perform similarly in the two markets, A shares [shares in mainland China-listed companies traded in Shanghai and Shenzhen] in general are trading at a premium of about 23.18 per cent to H shares [shares in Chinese companies listed on the Hong Kong Stock Exchange], according to the Hang Seng China AH Premium Index which tracks the price gap between the two.
A reading of 100 would mean no price gap, but the index stood at 123.18 per cent on Friday, November 25, compared with 148.84 in January 21. The gap remains, but at least it’s narrowing.
In the most extreme case, Luoyang Glass H shares traded at HK$5.56 in Hong Kong on Tuesday, while its A shares traded in Shanghai at 25.61 yuan, representing a premium of its A to H shares of 417.45 per cent.
Even with the stock connect in place, few investors sell expensive A shares to buy cheaper H shares, and pocket the difference.
One reason for this could be that cross-border turnover is still much lower than the domestic pool of investors.
International investors trading in Ashares still only represent between 1 and 2 per cent of Shanghai’s total turnover, while mainland investor trading represents 5 to 10 per cent of Hong Kong’s turnover.
Louis Tse Ming-kwong, director of VC Brokerage, said the views of Hong Kong and mainland investors vary on certain stocks, which adds risk if any try to take profit from arbitrage by trading in the two markets.
“Mainland investors tend to like to invest in stocks that might benefit from government policies while foreign investors put more emphasis on fundamentals.
“If a mainland investor sells Luoyang Glass A shares in Shanghai and buy its H shares in Hong Kong, they look cheap.
“However, if a foreign investor sells H shares to buy popular mainland stocks to generate profit they are likely to get their fingers burned,” he said.
Currency is another key issue in the mix, Tse said, as A shares are priced in yuan and H shares in Hong Kong dollars.
“Some mainlanders have been buying H shares via the stock connect as they are worried about the devaluation of the yuan. But these investors are not doing arbitrage, they are only trying to hedge against the falling currency,” Tse said.
Henry Chan, chief investment officer at BEA Union Investment Management, thinks the persistent price differential between A and H shares is explained by the divergence in investor preferences and considerations between the markets.
“The fact that it is the same underlying company does not mean the two listings will always trade at the same price. Look outside the A-H space, and we see continued price divergences in dual listings such as BHP, Rio Tinto and Brambles, all of which are listed on both the Australian and UK stock markets,” Chan said.
Ken Wong, Asia equity portfolio specialist at Eastspring Investments, said there are no arbitrage opportunities between Hong Kong and Shanghai because the two markets’ shares are not fungible, and cannot be bought and sold in each other’s respective markets.
“We don’t believe that the Shenzhen-Hong Kong Stock Connect will play a big difference on the valuation gap, especially given that Shenzhen stocks tend to trade at even higher multiples.”
The Shenzhen stock market now trades at an average price-earnings ratio of 44.59, compared with the Shanghai stock market’s 16.49 times and Hong Kong’s 0.79.
Timothy Lo, a managing director at French private bank CIC Investor Services, said A shares were trading at a premium to H shares, even before the Shanghai-Hong Kong Stock Connect was introduced two years ago.
“Bear in mind, all Hong Kong and overseas investors are allowed to trade eligible shares listed in Shanghai, while only mainland institutional investors and individual investors who have 500,000 yuan in their brokerage account are eligible to trade in Hong Kong.
“Hence there are some retail investors who cannot meet this criteria, and are left with no alternative but to invest in A shares, which of course are trading at a premium, relative to H shares,” Lo said.
“The difficulties in borrowing capital to buy A shares, and naked shorting [short selling shares that have not been affirmatively determined to exist] in the A-share market is prohibited, make it less likely to have arbitrage activities between the two markets.”
Keith Pogson, a senior partner at EY, said although the Hong Kong and Shanghai stock markets are connected, there is little arbitrage as the two markets are actually very different.
“The Hong Kong market is a mixture of global and local Hong Kong money, often more focused on value and global market issues such as the overall sentiment towards China.
“The mainland domestic markets are often much more susceptible to short-term movements around specific stocks and closer to rumours about macroeconomic policy changes and stimulus initiatives by the central government and others in Beijing and across the country,” Pogson said.
“These drive fundamentally different assessments of value. Without the ability to physically deliver one of the stocks into the other market, it is unlikely that the premium and discount gap will actually be arbitraged anytime soon,” he said.
Brett McGonegal, chief executive of Capital Link International, said since A and H shares are not fungible and are traded in different currencies, the arbitrage play exists “only in a dangerous game of borrowing shares in one market and currency, and buying them in another with the same variables and trying to get the variables to not eat into one’s profit”.
“It is not very easy to set up a traditional arbitrage situation [a combination of both value and growth investing] and one runs the risk of a host of things going wrong or costing too much,” McGonegal said.
Joseph Tong Tang, the chairman of Morton Securities, said the A- and H-share price gap will continue to exist until the mainland’s capital flow and other investment restrictions are loosened to levels similar to Hong Kong.
“The Shenzhen-Hong Kong Stock Connect is aimed at moving in that direction, but I expect the gap will remain in the foreseeable future,” Tong said.
Mark Konyn, group chief investment officer of AIA Group, said as China’s market liberalisation continues, investors can expect the valuations between A and H shares to narrow.
“Further deepening of the capital markets, including the introduction of derivatives and hedging instruments over time, will support convergence between A and H shares.”