Major News and Events:
China Announces Cross Border Trading Access: Impact on A:H Discount & Potential Inclusion of Mainland China Equities in Broad Benchmarks
In a ground-breaking decision put forth by China’s Premier Li Keqiang and formally announced by both the China Securities Regulatory Commission (CSRC) and Hong Kong’s Securities and Futures Commission (SFC), investors will finally be allowed to trade between the Shanghai and Hong Kong Stock Exchanges.
This announcement marks the first time that investors in Hong Kong will be able to directly access certain Mainland A shares listed on the Shanghai Exchange and vice versa as Mainland investors will be able to directly access certain Hong Kong listed companies. Previously accessibility was only allowed through China’s investment quota systems.
This is the clearest indication yet of China’s desires to open up its capital markets and is also in keeping with the decision by policy makers in Asia’s largest economy to promote Shanghai as a financial hub. Shanghai inaugurated a free-trade zone in September of 2013 as part of a goal to become a global financial and logistics center by 2020.
• Exact timing and guidelines for trading between the Exchanges should be available within 6 months
• Cross-listed companies (listed on Shanghai and Hong Kong but not fungible) are expected to be included in the new plan.
• Large and mid-cap names will likely also be included. The inclusion of cross-listed companies should be an important step in closing the large discount Mainland (A shares) have traded at in comparison to their Hong Kong (H share) counterparts.
The discount in cross-listed A to H shares has been particularly high amongst financials and insurers. Below are some recent discounts:
This announcement is expected to benefit H share technology/internet companies such as Tencent (KWEB and KFYP’s largest holding, at 10.4% and 17.6% of net assets respectively* as of 4/15/2014) as well as H share Macau casino names as there are limited if any investment options in these sectors for Mainland investors.
Mainland companies that are expected to benefit are those in the China consumer, healthcare and defense sectors. An added consequence of this announcement is apt to impact the composition and weight of China in MSCI indices.
Last month MSCI provided a roadmap for the potential inclusion of mainland Chinese equities in the MSCI Emerging Markets Index. The securities have been excluded due to the inability of foreign investors to access mainland Chinese equities. Only 260 institutions globally can access the mainland
markets via the Qualified Foreign Institutional Investor program (QFII). The Chinese government began a program called Remnimbi QFII which allowed Chinese asset managers to list mainland exposure ETFs in Hong Kong. The KraneShares Bosera MSCI China A (ticker KBA) utilizes RQFII to gain access to the mainland equities. We believe this announcement allows MSCI to begin inclusion of mainland Chinese equities as it does not require having QFII nor RQFII. Full inclusion of mainland Chinese equities should raise China’s current 17% weight to 27% due to the additional 10% allocation to MSCI China A within MSCI Emerging Markets. While MSCI will announce in June their decision regarding mainland equity inclusion, we believe they will proceed based on this recent development on mainland access.
Finally this announcement is a significant step forward, however there are still a number of large cap Chinese companies particularly in the technology space that are listed in the US and are therefore not eligible to be included in any broad China indices. KFYP and KWEB offer an alternative by providing access to both US and Hong Kong listed companies.
Pew Study: China is the Global Leader in Renewables Investments
For the second year, the annual Pew Charitable Trusts report titled, “Who’s Winning the Clean Energy Race?,” shows that China is the world leader in clean energy investment, with $54 billion in investments in renewables in 2013, well above total U.S. investment of $36.7 billion according to Bloomberg.
The Pew report cited China’s efforts to reduce poverty, increase domestic economic development and solve its air pollution problems as key drivers leading the country to invest heavily in clean energy. Though renewables market share is on the rise globally, the report said that overall worldwide renewables investment has been declining for two straight years. Investments totaled $254 billion last year, a decline of 11 percent from 2012 and 20 percent from 2011 when investments peaked at $318 billion.
China installed 14 gigawatts of electricity generation capacity from wind farms and 12 gigawatts of solar power generating capacity last year, whereas the U.S., which has seen a boom in domestic shale gas, installed less than 1 gigawatt of wind power after a tax incentive for the wind industry expired. The U.S. installed a record 4.3 gigawatts of solar generation capacity in 2013 according to the report.
China’s Power Sector to Open to Private Investment State Grid Corp of China, the country’s dominant power grid operator, will open up parts of its business to the private sector, according to Chinese news agency, Xinhua. This is in keeping with Premier Li Keqiang’s pledge for more private investment in the country’s state owned oil and power projects. Sinopec and Citic Group have also recently announced plans to open up their businesses to private investment.
The government-owned State Grid Corp, which operates 80 percent of China’s power grids, will open up three areas, including direct current ultra-high voltage (UHV) power transmission, pumped storage power stations and electric vehicle charging equipment, to private investors. Overall, China plans to install 70 gigawatts of pumped storage power capacity by the end of 2020, compared with the current 21.5 gigawatts available now. The country also plans to have 4,000 electric vehicle charging stations built by 2015. State Grid plans to build nearly 10,000 more charging stations from 2016 to 2020. State Grid also plans to invest 380 billion yuan ($61 billion) in power grid construction this year, one third of which will be spent on UHV power grids, according to its “social responsibility report” in February.
Strategists See China Buying Opportunity
Mark Mobius, who runs Templeton’s Emerging Markets Group with approximately $50 billion in assets under management, said he’s buying technology stocks after a global selloff left companies such as Tencent Holdings trading at “reasonable” valuations according to a Bloomberg interview. Mobius cited Tencent as an example, “it’s come down about 20 percent and that’s a pretty good correction,” otherwise declining to name any specific stocks he’s buying. JPMorgan Asset Management Ltd. has also said they are acquiring technology shares. “We have been selectively buying some internet stocks in Asia,” said Grace Tam, a Hong Kong-based global market strategist at JPMorgan Asset. “As long as they can deliver earnings growth, we still believe they have strong fundamentals. We’re still quite positive on the sector in the medium term,” Bloomberg reported.
Mobius believes that investor concern that a flood of initial public offerings in the technology industry would weigh on existing share prices has eased. “A lot of people were concerned because of the number of new issues coming in the U.S. market,” Mobius said. “I think that’s probably coming to an end now.”
Alibaba Continues to Invest
Alibaba, China’s largest e-commerce company by sales, recently made an offline move by announcing an investment in brick-and-mortar retail stores. The South China Morning Post reported that the company spent $692 million in acquiring a 9.9% stake in Hong Kong-listed Intime Retail, one of China’s largest department store operators. Intime runs 28 department stores and eight shopping malls. The deal includes establishing a joint venture that operates independently. Analysts view this as a potential industry model unifying online and offline merchants, payment services and big data analysis.
It’s not the first time the two companies have joined together—Intime participated in several promotion campaigns on Alibaba’s Tmall platform, including the “Single’s Day” sale on November 11, 2013, considered China’s version of Black Friday for shoppers.
Local Broker Insight:
Sealand—Q2 Outlook—The new leadership is determined to promote reform allowing the market to play a decisive role in resource allocation, which is reflected in market-oriented risk pricing, indicating that debt defaults may be commonplace for the foreseeable future. This could cause credit to tighten and interest rates to rise. The government’s tolerance for slow economic growth may be stronger than expected and employment pressure may not surface as soon as expected. http://www.ftsfund.com/index.shtml
Galaxy—Policy—The PBOC tightened supervision on internet finance last week and is considering establishing a monitoring and statistical data system targeting shadow banking, in order to strengthen supervision of
financial innovation. Meanwhile policymakers are encouraging market-oriented financial innovation to activate and efficiently utilize existing capital. http://www.chinastock.com.hk/en/ACG/ContactUs/index.aspx
CICC- A-share Strategy- Growth to recover and reforms to speed up
• Looking ahead to 2Q14, we expect growth to recover and reforms to speed up, with the latter helping to relieve the pessimism about “old economy” blue chips, while going against high valuation “new
economy” small-/mid-caps, prompting further style change.
• We maintain our forecast for 15~20% return on A-shares in 2014, supported by earnings growth, while reforms will ease challenges, improve sustainability and unleash market values depressed by
pessimistic expectations.
• Our model portfolio continues to tilt toward “old economy” sectors and we continue to recommend overweighting cyclicals, mass consumer goods with reasonable valuations and to avoid sectors with higher valuations and not yet stabilized fundamentals.
• On SOE reforms, we favor new entrants, enterprises likely to improve earnings further, those likely to see turn around, and also those likely to see hefty dividends.
• Also look for IPOs and preferred shares issuances to begin in 2Q 2014. http://www.cicc.com.cn/index_en.xhtml?locale=en