Wide gap for China mainland, offshore stocks may be hard to bridge

By Clement Tan

HONG KONG, Nov 28 (Reuters) – Investors looking to exploit the widest gap in three years between the performance of mainland and offshore Chinese stocks could well get their fingers burnt.

H-shares, or Chinese stocks listed in Hong Kong, are trading at their biggest premium to mainland-listed A-shares since October 2010, as offshore investors cheer Beijing’s bold economic reform plan unveiled this month.

The H-share benchmark index surged 7 percent last week alone, its biggest weekly gain in nearly two years, outperforming a 2 percent rise for the CSI300 index of leading A-share listings during the same period.

Qualified foreign investors may see the gap as an opportunity to switch into the A-shares of dual-listed Chinese companies whose H-shares have outperformed. This strategy could backfire, however, as the contrasting liquidity situations in the two markets suggest the gulf could remain for some time.

“Theoretically, you could go long A-shares and short the H-share market, but I wouldn’t be in any hurry to do that now,” said Hong Hao, chief equities strategist at Bank of Communications International.

“With liquidity so tight in the mainland and improving in Hong Kong as global funds start to allocate more money to offshore equities, you are going to end up getting squeezed on both sides,” Hong said.

Encouraged by Beijing’s reform agenda, funds in the offshore market in Hong Kong are upgrading to a more neutral position from a previous underweight stance on Chinese stocks.

Low valuations are also proving attractive, with offshore Chinese equities trading at their biggest discount to shares in Asia, excluding Japan, since the 2008 financial crisis in price-to-earnings terms.

“I think Beijing’s made it quite clear what it wants to do to reform the economy and global funds are starting to reposition themselves,” said Xing Hu, a China fund manager with Edmond de Rothschild Asset Management.

CASH SQUEEZE

But the enthusiasm for Chinese equities offshore has yet to spill over to the mainland, where investors are chafing under a lingering cash squeeze in the money market. Still fresh in their minds is the 15 percent dive in the onshore stock market in June sparked by a cash crunch at the end of that month.

The last two times that H-shares traded at such a big premium – in October 2010 and January 2011 – a strong A-share rally followed and erased the premium in a matter of weeks, but liquidity on the mainland was not so tight back then.

The A-share market has historically traded at a premium over H-shares, primarily because of capital controls in the mainland and inflated valuations in a largely retail-driven market.

Only approved foreign institutional investors have access to the A-share market through limited quotas and they amount to about 2 percent of the 24.4 trillion yuan ($4 trillion) market.

But with the A-share market heading towards a fourth year of anaemic returns, that premium – which was as high as 100 percent in January 2008 – has flipped to a 6 percent discount as onshore investors have fled the stock markets and sought relatively higher yields in fixed-income securities.

Some investors say arbitraging the gap between A- and H-shares occurs on a stock-specific basis rather than an index level.

“It’s difficult to take the broader A-H premium index as a basis, because benchmarks are very bank-heavy and the premiums-discounts vary greatly among components,” said Lilian Leung, who manages the $871.5 million JP Morgan China Pioneer A-share Fund.

Even then, Leung said any premium or discount would have to be more than 30 percent over a sustained period of time before she decides on a switch for any dual-listed stock. She declined to elaborate.

The biggest H-over-A share premiums are seen for the non-banking financial sector, a popular financial reform play. Ping An Insurance’s H-shares are trading at a 39 percent premium to its A-shares. (Editing by Saikat Chatterjee and Chris Gallagher)

This was first published at Reuters.com.