Saturday, June 23, 2007

Impact of A Share H Share and Red Chip Convergence to 3 ETF (CAF, FXI, A-50 Tracker)

"There's no reason why stocks listed in Shanghai cannot through some financial instruments be traded in Hong Kong. Similarly, I do not see why Hong Kong stocks cannot be co-listed in the Shanghai stock market through an arbitrage arrangement. We are discussing the mechanics of it."

Hong Kong SAR Chief Executive Mr. Donald Tsang said in an interview with Financial Times on 18 June.

Mr. Tsang is a very smart politician and he is especially good in gaining trusts from his bosses in Beijing, that’s why he could replace Mr. Tung Chee Hua, the past HKSAR Chief Executive in the middle of Mr. Tung’s tenure.

Mr. Tsang has also been very cautious in delivering messages from Beijing, he would not disclose any plan on change of Chinese policy unless it is 100% confirmed.

As such I would expect new policy leading to price convergence of dual listed shares in Hong Kong and China would be announced very soon.

The convergence has in fact already been started, we see a very strong upward momentum of Hong Kong listed Chinese companies since the Chinese market correction earlier this month. See the chart below comparing SH Composite with HSCEI (Hang Seng China Enterprises Index):

A Shares in Shanghai or Shenzhen are trading at premium to their H share counterparts listd in Hong Kong. As of 22 June H shares are discounted by 1.5% to 88%.

If you are holding any funds or ETF with A, H or Red Chip as underlying assets, you shall evaluate such convergence impact immediately.

Three such most common ETFs traded in US and HK are :

  1. Morgan Stanley China A-Share Fund (CAF)
  2. iShares FTSE/Xinhua China 25 Index (FXI)
  3. iShares FTSE/Xinhua A50 China Tracker (2823.HK)

Following is my analysis of the potential impact to these 3 ETFs:

As the actual market reaction is impossible to predict, I’ve made the following assumptions in my analysis:

  • Only constituents of each fund which are dual listed in HK and China are considered
  • Uniform convergence of each dual listed stock
  • The price gap between H and A share would not be completed closed, for illustration purpose I assumed H shares to go up by 70% (of the gap) and A shares to go down by 30%.
  • Correlation of H share and Red Chip movement is ignored.
  • Impact to "A only” shares (i.e., not dual listed as “A” and “H”) is ignored.
  • Similarly impact to Red Chips is ignored.

In this TABLE I listed the H share discount for all 44 dual listed Chinese shares, composition break down for each of CAF, A-50 and FXI, and multiplied the discount and composition % to arrive at the potential impact. You can study the impact down to each stock in the table if you are interested.

In summary:

FXI has 39.55% of NAV invested in 10 H-Share companies (out of the 44 dual listed) giving a positive upside potential of 7.7%

CAF has 22.25% of NAV invested in 7 A-Share companies (out of the 44 dual listed) giving a potential downside of 1.8%

A-50 Tracker has 30.3% of NAV invested in 20 Chinese A-Shares Access Product (out of the 44 dual listed) giving a potential downside of 2.2%

Several Very Important Remarks :

  1. My assumption of uniform price correction to all dual listed stocks is for simplicity only. I expect high quality H shares would experience a stronger re-valuation. So buying those shares with heaviest H discounts would not guarantee you profits.
  2. As Red Chips will be returning home to list as A share in China too, we can anticipate similar re-valuation of those Red Chips, which is beneficial to FXI (or other funds or indices with strong Red Chip exposure) as it holds several high quality Red Chips such as China Mobile and CITIC Pacific.

What is my investment strategy to profit from this trend?

I have bought HSCEI index products, on top I have overweighed several selected H shares and Red chips as potential profit enhancers. How to pick those star companies? Let's discuss together in my Discussion Group !


Anonymous said...

A-50 Tracker's stock code? shows that A-50 tracker's stock code is 2801, see

In you article, it is, I am a bit confused. Can you help?


Zhong Siwei 鍾思維 said...

2801 tracks MSCI China index which is different from A-50

you can compare the compositions for details.

2801 tracks more companies than A-50.