All news are good news

Being based in HK, what are currently happening in US is nothing new to us. Our property market collapsed after 1997 and it took almost 10 years to recover, we have SARS in 2003 that hurted our economy to an unprecedented extent. Both of these are not minor issues and experience tells us that it will take long time to recover.

However, when I look at the recent market reaction globally, people are ignoring all these facts.

Is the housing market really reached a bottom in US? Even if it is how quickly can it recover? In HK it was 10 years and not 1 or 2 years which Bernanke or Obama trying to pitch. Well, both of them are having probably the most difficult job in the world, if I were them I probably will do the same thing, the only solution to the subprime aftermath is to re-inflate the bubble.

I believe the Swine Flu impact may not be as serious as SARS, however, still I will not underestimate the risk. But most people's reaction in US is just life-as-usual.

I cannot really understand what's happening over the last few weeks when all news become good news. The only thing I learnt is that I shall never work against the market trend, I short the S&P 4 weeks ago and it proved to be a big mistake.

Having said that, how long can this all-news-are-good-news trend last? I still have reservation.

Q1 earning season is over, market interpretation to most of them is simply not-worst-than-the-worst means it's good and we see stock price jumped. Do we still look at PEG in valuation? what's the new 'G' in the ratio? Market simply ignore it.

CAF (the China A Share ETF that I followed very closely in the past) has reached an all time high 40% premium, while the historical high was about 20% since its launch in 2006. What does that tell us?




On the other hand the A-50 ETF (HKSE: 2823) premium is still trading at close to zero, given there are choices I will rather bet on A-50 if we believe the Chinese market is on a sustainable uptrend.

For more background on CAF and A-50, you can read a very old story I wrote 2 years ago, the link is here, though the story is old but the background doesn't change

A50 Tracker and HS China Enterprises Index (HKCEI) Technical Analysis

Just want to share the following two set of charts, seems like no charting tool can concurrently display two MACD, I've manually paste the A50 (using 2823.hk as proxy) and HSCEI MACD side by side to better analyze the two recent opposite trends.

In hindsight, should have been alerted in early August when HKCEI MACD was developing a stronger and stronger negative divergence.

Currently A50 is also developing a negative MACD divergence, will it develop further and it's a sign of A-share market correction?

I’ve no crystal ball but I am a bit cautious about the recent policy risk developing in China based on what I observed and heard:

• No action has been taken yet on the 5.6% July CPI figure which was announced last Monday
• Rumours of new housing loan policy with down payment increased to 50% and no new loan for 2nd home

For anyone interested in treasure hunt HK stocks, especially those new IPO listed since 2006, here is an analysis of all Hong Kong IPO performance for 2006 and 2007.

Two New China A-share ETFs Launched in Hong Kong

Two new China A-share related ETFs listed in HK last week, they are:

HSBC Dragon Fund (0820.HK)
An actively managed closed end China concept fund with up to 50% of portfolio invests in A share, remaining 50% in H-share, Red chip or B share. Fund NAV is updated daily here

Profile of manager extracted from prospectus:

Richard Wong
Richard is a fund manager in the Asia ex Japan equity team. He has overall responsibility for investments in the Chinese equity market. Richard has been working in the industry since 1985. He first joined HSBC Investments in 1993, then left to work for Nikko Capital Management as a senior portfolio manager for one and a half years. Richard returned to HSBC in 1997 and moved to Halbis upon its establishment in 2005. Richard started his career at Moody’s Investors Service as a research associate in New York. Richard holds a BA in Economics and Computer Science from Columbia University and an MBA in Finance from New York University.

BOCI-Prudential W.I.S.E. - CSI 300 China Tracker (2827.HK)
which tracks the CSI300 index. The index consists of the largest 300 A-share companies traded in Shanghai and Shenzhen stock exchanges. Fund NAV is updated twice daily here.

Apart from a wider coverage than the A-50 index (which can be good or bad), significance of the CSI 300 index is that it is being chosen as the underlying index for the coming China index future which is yet to be launched.

Market reacted very favourably to the HSBC Dragon Fund, in fact is truly alarming to me. Today is the 2nd day of listing and it’s trading at ~70% premium to NAV. As this is a new CEF 100% of its assets is in fact cash.

CSI 300 Tracker is trading comparatively ‘humble’ with 13% premium.

When we look at other similar funds, Morgan Stanley China A-share Fund (CAF) is trading at ~15% discount. A-50 China Tracker (2823.HK) trades at ~1.7% premium.

So practically people are anticipating the HSBC manager will beat the China market by at least 70% !

Not sure whether I am too stupid and not able to understand the secret rationale for paying $170 cash for $100 cash + a remote wish. I’ve NOT seen any active China fund which can beat the already very high growth A-share market index by extra 70%!

OK, let’s look at history and check on historical 12-month premium of some other popular emerging market ETFs.

Here I listed several of them which I’ve been closely following:

Morgan Stanley China A Share Fund (CAF)


Templeton Russia & East European Fund (TRF)

India Fund (IFN)

Morgan Stanley India Investment Fund (IIF)


As can be seen from those charts, most of the emerging market funds had their premium reached a peak around Dec 2006 timeframe. The highest premium was 38% with Templeton Russia & East European Fund (TRF) and that for Morgan Stanley China A Share Fund (CAF) was ~16%.

This new HSBC Dragon Fund (0820.HK) for sure has broken a lot of ETF records and I wish all those who invested in this ETF good luck and have their wishes come true. On the other hand, the HSBC manager can in fact consider buying CAF at its current 15% discount to lock in some immediate returns.

Will I buy the CSI300 tracker? No, I would rather stick with A-50. I am only interested in those true market industry leaders listed in Shanghai. For those smaller companies (in CSI300) listed in Shenzhen, my gut feeling is that the return/risk ratio will not be as good as A-50. Besides, I am not going to pay 13% premium with CSI300 Tracker when I can pay 1.7% for higher quality stocks (with A50), this is apple-to-apple comparison as both are listed in HK versus CAF which is listed in US and investors there are trading the ETF at a discount instead of premium.

Today I've opened a new LONG position in a HSCEI index linked derivative, with the interest hike and interest tax reduction announced last Friday, I believe it will be another few months of bull market before the next significant correction. Near term risk is the coming launch of the China Index Future, the exact plan is still unknown and that's the policy risk we are taking.

Top 5 most influential stocks of the Hang Seng China AH Premium Index

The Hang Seng China AH Premium Index ("AH Premium Index") was officially started yesterday, real time indices are shown in the following table:

Real Time Index:


I’ve further analyzed the composition stocks and ranked the top 5 stocks with the biggest impact to the index. They are namely China Life, Sinopec, Bank of Comm, Ping An and Chalco. 5 of them already contributed around 20% premium, with the remaining 22 stocks altogether contribute another 10% giving a total premium of ~30%. (as of 9 July)

The full table is shown here.

A-share companies will begin reporting of their half year results this month, China Merchant Bank and ICBC had pre-announced their result last night with impressive 100% and 50% net profit growth respectively.

While H-share has gained very strong momentum over the past 2 weeks versus its A-share counterpart, whether it can keep the steam going will be very much dependent on the result announcements this month.

I would refine my Q3/Q4 strategy after seeing those results. In addition to catching the A-H convergence, I would start accumulating Olympics related stocks. I expect the heat will start in 2H till the event takes place in Aug 2008. In terms of sector I would look at media, hotel and sports related companies.

A Very Important Index Is Launched - Hang Seng China AH Premium Index

HSI Services Limited announced today the introduction of a series of Hang Seng China AH Indexes to help investors track the performance of those Chinese companies dual listed in China and Hong Kong.

The most significant one is the Hang Seng China AH Premium Index (“AH Premium Index”), an index measuring the weighted average premium (or discount)of A-share prices to H-share prices of the constituents. The index is designed in a way that the higher the index, the larger the premium of A shares over H shares, and vice versa. When A-share prices are at par with H-share prices on average, the index will be at 100.

Initially the index will have 27 large AH companies that have completed share reform as constituents.



As at 27 June 2007, the AH Premium Index closed at 146.73, meaning A shares are trading at an average premium of 46.73% above H shares.


The trend from Jan 06 to Jun 07 is shown in the following chart.

How to play this index?

No tradable derivative product is announced yet.

However, if you believe the A-H price gap will converge like I do and cannot wait, one possible way to play is to long a number of the 27 constituents. Regardless of the structure of derivative product, issuer has to hedge its position by long H and short A (if the index is trending down, ie, tightening of the A-H gap).

Instead of looking at the full list of 45 A-H dual listed stocks, we shall better focus on this shortened list of 27. I've updated the full list HERE with level of H-share discount sorted in order.

The index will be available and disseminated starting 9 July 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 !

Chinese RMB Yield Curve

The yield curve adjustment in US market was the biggest event last week and the effect has rippled through to other part of the world. While China is a red hot subject nowadays, how come nobody talks about the Chinese RMB yield curve? Do you have any idea as simple as the shape of the curve?

You probably are not interested because RMB is not a freely traded currency, and you are not allowed to buy RMB bonds.

But are you investing in Chinese H-share or A-share based ETF such as Morgan Stanley A-Share Fund (CAF), iShares FTSE/Xinhua China 25 Index (FXI) or iShares FTSE/Xinhua A50 China Tracker (2823.HK) ?

Do you know all those funds are having a significant proportion of their assets invested in Chinese banks and insurance companies?

For example, the following list shows the 25 constituents of FXI, almost 40% of its assets are in Chinese banks and insurance companies



So how does this relate to the RMB yield curve?

If you are indirectly owning so much Chinese banks assets, you may be interested to know how do Chinese financial institutions manage credit risk, how do they perform mark-to-market financial assets valuations, how do they report VaR (Value-at-Risk) or CAR (Capital Adequacy Ratio) which are critical measurements of banks’ health.

In other part of the word, yield curve is the most fundamental element to derive discount rates for cash flow projection, which itself is the basis for any financial assets valuations.

However, you may be very surprised to learn that this seems to be obvious matter is a brand new policy just imposed last week ! On 15 June CBRC made an announcement that banks should make reference to RMB yield curves in financial assets valuation and reporting starting from Oct 2007. Before this is enforced Chinese banks are not referencing to RMB yield curve and they derive their own discount rates based on arbitrary and subjective measures. So there is in fact not a common point of reference when we interpret reports from different Chinese banks. Is the credit management of one bank better than the other as indicated from its annual report? I am not too sure.

It is still a very long road to a mature capital market in China. What we have seen in the A-share market is just a beginning of the overall Chinese capital market reform. Without a solid equity market foundation it would be difficult to move forward to develop a corporate debt market. RMB yield curves are in fact incomplete because secondary market for corporate bonds is inactive. Without a well developed debt market the Chinese goverment would find it difficult to solve banks’ non performing loan problems because there is not a vehicle for a more balanced distribution of risks to different classes of investors. Bank loans are currently the major source of funding for all Chinese firms. Based on PBOC statistics, in 2006 Chinese firms raised a total of RMB 4000b, of which RMB 3300b (82%) were bank loans, only 5.6% (RMB 230b) was from equity market.

My View

1. China is speeding up in debt market development which is crucial to the overall health of Chinese economy
2. A healthy stock market is the fundamental requirement for debt market development, I cannot believe the Chinese government will do any stupid things to destroy what they have painfully developed over the past few years. Tackling the astronomical sum of non performing bank loans and ultimately listing all banks were huge achievements. Though the system is far from perfect, it is a one way road, the Chinese market can only be healthier.

Finally, here is the RMB yield curve in case you are interested.

Filtering market noise in China

The inconsistent message from the Ministry of Finance about stock transaction duty tax hike caught the market by surprise and caused an almost 21% correction from its peak of 4335 on 29 May to its lowest of 3406 on 5 June to the Chinese Shanghai Composite index.

Though I’ve profited from my H-share and A-share index call warrants which I bought on 7 June, what interested me more is to see what lesson I can learn from the incident.

A recap of the chain of events:

22 May:

Market rumoured that transaction duty would be raised from 1% to 3%

23 May:

“Responsible representatives” (the exact wordings in Chinese are “有关部门负责人”) from Ministry of Finance and The State Administration of Taxation (国税总局) confirmed with a reporter of Shanghai Stock News (上海证券报) that they have not heard of such policy change. After such story was published by Shanghai Stock News, it was widely quoted by other online and print media in both China and Hong Kong.

29 May:

Ministry of Finance announced the 1% to 3% increase of transaction duty

I tried to dig out speific names of the spokespersons on 23 May. I’ve searched Baidu (the most popular search engine in China) and Xinhuanet which is the official China News Agency web site, my effort was in vain.

Anyway, I believe the comment from the unidentified persons were unintentional. Most likely the reporter from Shanghai Stock News was unable to approach related senior officials for comment and so he/she just picked anyone reachable. Unfortunately in this incident the individuals who provided comments might not have enough knowledge of what the real government plan was.

Catch you by surprise (出其不意)

This 29/5 incident reminded me of another one happened in July 2005 when China announced its currency policy reform with RMB referenced to a basket of currency instead of US dollar alone.

For that incident, Premier Wen Jiabao has in fact pre-announced his plan when he told the world his intention. Back on 14^th March 2005 Premier Wen has told the media that China was planning on a significant currency reform and he further added that “it might catch you by surprise” (出其不意) when being asked about the timing.

What were the differences between these two incidents?

• One comment was made by an anonymous person while the other was made by a highly respected Chinese leader.
• One was to cool down (not to kill) the local stock market while the other was to avoid foreign speculators to take advantage of the RMB appreciation.
  

So what have I learned?

1. I will take comments from unidentified sources with a grain of salt.
2. Any significant correction caused by rumours in China is good buying opportunity (the Feb correction was also caused by rumours of same nature). Refer to the chart below to see how quickly the two corrections were fully recovered. I maintained my long term bullish view on China.
   

1. 

3. A-50 tracker ETF (2823.HK) is the best instrument I can access having the highest correlation to Shanghai index. I was using CAF as a proxy but it proved to be a failure. CAF is still having 20.9% discount to NAV while A-50 Tracker (2823.HK) has almost completely closed the gap with only 2.6% discount as of today’s closing. Why CAF is lagging? Apart from supply/demand dynamics the performance of its underlying against index is other contributor.
   

A-Share Price Premium

A share and H share trade in two different markets (Shanghai/Shenzhen vs. Hong Kong) and there is no channel to arbitrage, adding to that the huge imbalance between supply and demand of high quality stocks in China has caused most A shares to trade at a premium over their H share counterparts.

The premium ranges from a few percents to several hundred percents when translated into HK$ equivalent.

For ease of reference, I would from time to time publish such table. Stay tuned !

Morgan Stanley China A-share Fund (CAF) Top 10 Constituents Performance Relative to Index

The following table shows the top 10 holdings of CAF (Morgan Stanley China A-share Fund) as of last report.


To understand the stock picking skill of the manager, I have extracted the relative performance chart of each stock against Shanghai Composite, these charts are dynamic and will be updated daily.

In each chart, RED line is the Shanghai Composite Index, BLUE is constituent stock.



Individual Stock Vs. SH Composite (latest 3 months)

600015 Huaxia Bank Co. Ltd


600036 China Merchants Bank Co. Ltd


600005 Wuhan Iron & Steel Co. Ltd



601111 Air China Ltd



600000 Shanghai Pudong Development BA


601006 Daqin Railway Co. Ltd


600066 Zhengzhou Yutong Bus Co.



600808 Maanshan Iron & Steel



000022 Shenzhen Chiwan Wharf Holdings




000612 Jiaozuo Wanfang Aluminum Manuf

Who Moved The Chinese Market?

Shanghai closed today at 3890.8, up 3.03%. It is also the first time that there are more advances then declines (894 vs. 378) since the announcement of the tripled duty tax on 29 May.



Over the last 7 trading days, Shanghai Composite has corrected by 21% from its peak of 4335 on 29 May to its lowest of 3406 on 5 June, and still by 10% as of today.


This size of correction is totally unexpected by the government, over the last 2 days there were various government officials trying to comfort the over-reacted crowds with bullish comments in different media.

In addition, 4 new equity oriented mutual funds are approved and will be launched next week. Last time when a large number of funds were concurrently approved was on 6 Feb, when the market collapsed by 10% from 30 Jan to 5 Feb.

Obviously the government is trying to fix the aftermath.

So what was the cause for this latest correction? It was not the tripled duty tax, as I mentioned in my last article the practical impact of it is insignificant.

The real cause was the poorly managed and inconsistent message from the government. Just a few days before the 29 May announcement was made by the Ministry of Finance, the media had confirmed with another spokesperson of MoF that there was no such plan.

It is exactly this inconsistency which caused the market panic, as investors have no clue which message could they trust in future.

I think such inconsistency was unintentional, I believe Chinese authorities would learn from this incident and be more careful when government officials talk to media.

Another by-product of this correction is a tightening of the A-share/H-share price gap from the previous 30%+ premium exhibited by A-share. As can be seen from the chart below the Hang Seng China Enterprises Index (which tracks H-share in Hong Kong) has in fact gone up while the A-share index was free falling in the period.




This is the first time inexperienced Chinese investors (17% of the total trading accounts in China were freshly opened in past 4 months) got their fingers burned, at least for a period of time that 17% of the retail investors would remember this incident.

I believe Chinese investors would also start looking at other less risky investment vehicles which they are familiar with, such as QDII (Qualified Domestic Institutional Investor) funds the government recently relaxed. (Up to 50% of a QDII approved fund can be invested in equities from 0% in the past). As Hong Kong is the only authorized market QDII funds can put their money, most of such funds would likely allocate their equity portion to Hong Kong listed H-shares, red chips and Hong Kong blue chips which are all familiar names to Chinese investors, that would be a catalyst to H-share index though the absolute amount is still small comparing to the HK market cap.

Besides, there are more mainland Chinese investors using a grey channel to invest directly in Hong Kong stocks without going through QDII. Though RMB is not a freely traded currency, Chinese citizen is allowed to buy up to US$50K per year for their spending when they travel to Hong Kong. For a family with 3 members it’s already US$150K which is not a small number at all from Chinese standard. Though officially it is not allowed, still some of them would open a HK stock trading account when they travel to HK and place orders over internet or phone. In fact a local Hong Kong broker said today around 50% of its orders are coming from mainland customers. I would not under-estimate this effect which would even be more significant than the QDII channel.

I’ve also adjusted my trading strategy and would allocate part of my portfolio to H-share index ETF (2828.HK) rather than purely on A-share related ETFs (CAF and A-50 Tracker). Now I am equally bullish on both A-share and H-share.


Disclosure: I have LONG positions in H-share index call warrant and A-50 index call warrant

Relative attractiveness of H-share Fund vs. A-share Fund

Hong Kong market reacted very favorably to Chinese policy maker’s relaxation of QDII (Qualified domestic institutional investor) restrictions, Hang Seng Index and Hang Seng China Enterprises Index (HKCEI) went up 2.49% and 5.35% respectively yesterday.

China started the QDII program in July 2006, allowing QDIIs to raise renminbi funds from domestic individuals and institutions and convert them into foreign currency for overseas investment. So far, 30 financial institutions (11 domestic banks, seven foreign banks, 11 insurance companies and one mutual fund) have been granted QDII status. Total quotas granted are about US$19B (~ RMB 146B), which is about 2.7% of free floated A-share market cap. Previously QDII funds were only allowed to invest in fixed income products until last week when the Chinese government announced removal of such restriction. Under the new policy QDII funds are allowed to invest up to 50% of assets in overseas stocks and structured equity products, with no more than 5% of assets invested in any single stock. Hong Kong is the only market endorsed by the Chinese authority for such investments and as such there is a high expectation that HK listed H Shares, Red Chips and blue chips would be the major beneficiaries of this new policy.

Can the latest relaxation increase QDII’s attractiveness to Chinese investors?

Take a typical Hong Kong equity fund as reference, the Manulife Hong Kong Equity Fund retuned 31% in last 12 months, and 23% annualized in last 3 years. Even if the performance of Hong Kong market is still as promising as it did in the past 3 years, any QDII fund with 50% investment in equities (mainly Hong Kong listed blue chips, red chips and H-shares) can provide no more than 10-15% annual return. So is that a strong reason for Chinese investors to re-balance their portfolios into QDII funds?

Now let’s examine the following figures :

The size of Chinese household saving is 3.2 times of the free floated A-share market capitalization, i.e., Chinese are only investing around 30% of their savings into stock market. (Taking corporate saving into account, that would be around 15%). Though the QDII potential return is still far less than that provided by the A-share market, as the total size of QDII is only 0.4% of the total domestic saving pool, it would be easy to siphon such tiny amount from the huge pool to Hong Kong especially for corporate clients who aim at longer term investment horizon.

Is Hong Kong’s market reaction justified?

As can be seen from the above table, QDII is only 1/96 of the total market cap of Hong Kong Stock Exchange, and 1/48 of those Hong Kong listed H and Red Chips. The best case scenario shall further be halved as only up to 50% is allowed to be invested in equities. Look at it from another angle, total fund size of QFII is around 1.5 days of Hong Kong Stock Exchange’s trading turnover. (~HK$50b daily). Based on the above figures, investors may have over-reacted to such news.

Is H-share a more attractive investment than A-share now?

Will QDII close the gap of those dual listed stocks with H shares on average having ~50% discount over their A share counterparts ? Is that a good opportunity to switch from A-share funds such as Morgan Stanley China A-share Fund (CAF) or iShare A-50 tracker (2823.HK) to H-share funds such as Hang Seng China Enterprises Index (“H-shares Index”) tracking ETF (2828.HK)?

My view is that, unless there are drastic change in Government policies leading to a hard landing, A-share market is still more attractive than H-share because the craze can sustain for a long period of time:

• A-share traded in a closed market, only domestic investors or QFII can participate, as a result more rational international investors would have no impact to A shares market price. (because total QFII quota is only a negligible 1% of A share market cap)

• Investment alternatives to local investors are extremely limited, apart from parking their money with saving accounts which give ~2% after tax return, they can only invest in property, stocks and mutual funds.

• Chinese investors speculate on mutual funds the same way as they do on stocks, they have a common mis-conception that lower priced funds would provide higher upside, what they do is to redeem old funds and subscribe to new and ‘cheaper’ funds. To supply ‘cheaper’ funds to the market, managers will split old funds into sister funds so as to lower the unit NAV and make the new sister funds look ‘cheap’. Besides, more and more new funds are introduced to the market to address investors’ huge demand which will push the market even higher.

• As of end of April, domestic individual equity accounts has reached 94 million which is over 7% of population. New account openings on April 30 alone exceeded 1 million, and total new individual account openings in the month of April exceeded the sum of years 2005 and 2006. As a result, about 17% of the total existing accounts were opened just in the past 4 months. Suddenly investment related books become top sellers in all bookstores, investment talk shows also flooded all TV channels. There are more gamblers than investors in China, what can you do to stop gamblers from placing higher bets? I’m not saying investors in Hong Kong are not gamblers, otherwise Hong Kong would not become the largest warrant market globally in terms of turnover. The only difference is that Hong Kong investors in general have a higher level of risk awareness. Most investors in China with only a few months' investment experience have never experienced any major market correction and never burnt their fingers before.

As a result, I believe the A-share craze will still go on until one of the followings happened:

Chinese Government starts dumping stated owned shares into market

Free floated A-shares constitute only around 30% of all issued shares, majority of the shares are owned by the Government. Apart from those ‘pillar industries’ such as Telecommunication, Banking and Insurance, Government can gradually reduce its holdings and increase the size of free floated shares. This is a more effective way to absorb the excess liquidity originated from household savings than increasing interest rates which would itself affect the well managed RMB appreciation rate.

Introducing Index Futures

Currently Chinese investors can only bet one way as there is no channel to express pessimism.

Trial run of index futures has already been started and the initial trial result was that it significantly increased market volatility, as such it is believed that the policy maker will need more time and further estimation of the impact before such products are introduced to market.

Unless the above happened I think other measures such as imposing capital gain tax, increasing interest rates (unless a drastic increase or very frequent small step increments) etc could hardly clam down Chinese investors’ overly excited sentiment.

If the Government cannot or do not want to manage the “P” in P/E, what it can do in the meantime is to increase the “E” so as to lower the P/E to a more reasonable range:

Injection of profitable unlisted assets into listed company

• For example, Guangzhen Railway (0525.HK,ADR: GSH,601333.SS) returned home and listed as A-share in Shanghai in Dec 2006. The newly raised proceed RMB10.3B was used to acquire new railway assets from its mother company. With the acquisition Guangzhen Railway’s total railway operating distance is extended to 481km from 152km, however, it is still only a faction of the 4400km owned by its unlisted mother company. This is an example of the huge assets injection potential.

Red Chip Companies To Return Home

Under the current policy Red Chip companies (e.g. China Mobile, CITIC Pacific) are not allowed to list in Chinese market because those companies are not registered in China. It is rumored that policy amendment is ready and Red Chips can return home very soon. With such high quality listings Chinese investors would have more choices and hopefully they would divert their investments into those less risky stocks.

To conclude, I do not believe the price gap of H and A dual listed shares will be completely closed though it would be tightened a bit because A share price is going up at a much faster rate than its H share counterpart. I would maintain my long term positive view on A share market performance. In the meantime I would closely monitor Government’s action such as introduction of index future.

Disclosure: I do not own any of the above mentioned stocks

A Comparison of 3 Hong Kong listed H-share/Red chip ETFs

In addition to Morgan Stanley China A Share Fund (CAF) and iShares FTSE/Xinhua A50 China Tracker (IFXAF.PK or 2823.HK) I have discussed previously, alternatively we can also capture the Chinese opportunities by investing in HK listed index tracking ETFs.

First of all if you need definitions of A-share, H-share and Red Chips, here you are:

A-Shares
Securities of Chinese incorporated companies that trade on the Shanghai or Shenzhen stock exchanges, quoted in Chinese Renminbi (RMB). Traded by residents of the People’s Republic of China (PRC) or international investors under the China Qualified Foreign Institutional Investors (QFII) regulations.

H-Shares
Securities of companies incorporated in the PRC and nominated by the Chinese Government for listing and trading on the Hong Kong Stock Exchange, quoted and traded in HKD. Those from the PRC are not allowed to trade H shares however there are no restrictions on international investors.

Red Chip Shares
Securities of Hong Kong incorporated companies that trade on the Hong Kong Stock Exchange, quoted in HKD. The constituents are substantially owned directly or indirectly by the Chinese Government. Those from the PRC are not allowed to trade however there are no restrictions on international investors.


Now lets examine 3 such ETFs listed on Hong Kong Stock Exchange, especially on their constituents:


1. iShares MSCI China Tracker (2801.HK)

2. H-Share Index ETF (2828.HK)

3. Hang Seng FTSE/Xinhua China 25 ETF(2838.HK)

iShares MSCI China Tracker (2801.HK)

• Top 10 holdings = ~61.5% of portfolio
• Both H share and Red Chips included

H-Share Index ETF (2828.HK)

• A freefloat-adjusted market capitalisation-weighted methodology. (lock up shares, directors shares, cross holdings and strategic holdings excluded)
  
• A 15% cap on individual stock weights applied to address the issue of dominance, if any, of selected stocks in the index following the freefloat adjustment.
• 37 constituents
• Top 10 holdings = ~77.2% of portfolio
• Include H-share ONLY

Hang Seng FTSE/Xinhua China 25 ETF(2838.HK)

• Includes the largest 25 Chinese companies comprising H Shares and Red Chip Shares, ranked by total market capitalization.
• Index constituents are capped at 10% of the total index.
• Includes stocks listed on the Hong Kong stock exchange (only)
• Free floated weighted
• Top 10 holdings = ~61.3% of portfolio

a bigger image is here

At first glance 2801 and 2838 are more balanced as they include both H-share and Red Chips, however, when we compare the price performance of the 3 ETFs over last 12 months, it is observed that their performances are similar, so the inclusion of the few Red Chips does not have too much impact to the fund performance.

I do not intend to spend time to study further which one out of the 3 is better, as that would very much be affected by the timeframe you are looking at and I would let the marketing people of those funds to do their jobs.

If we are to invest in any of them, we shall select the one with the highest liquidity, out of the three 2828.HK’s trading volume is comparatively higher, but in absolute sense it is still extremely low. On 7 May the respective turnovers are as follows, I’ve also included 2823 (A-50) and the total turnover of HK Stock Exchange of the same day for comparative purpose:

2801	HK$11M
2828	HK$25M
2838	HK$1M
2823	HK$705M
Total HKSE turnover	HK$67.9B

Finally let's do another comparison with 2823 (A-50) and CAF, it is seen that the A-share ETFs performed significantly better (over 50%) than the H-share counterparts, while 2823 (A-50) further outperformed CAF by about 25%.

CAF manager is having a hard time to beat the index !
[both CAF and 2823 are currently having ~10% discount to NAV, so even if we take away the discount CAF still under-performed A-50 index by ~20-25%]

Purely from historical performance perspective it seems like A-share funds are better choices than H-share funds, the question is whether this is a sustainable trend? Will H-share and A-share price converge (currently A-share is trading at around 30-50% premium over H-share for the same stock)? What's the impact of the changing composition of the H-share and A-share indices down the road? How would the changing QDII policy affect H-share?....

Stay tuned for my next article.

Disclosure: I've no position in any of the above mentioned stocks

Chinese Castle In The Air – China A-Share Market Craze

Famous economist John Maynard Keynes applied psychological principles to investment theory and pronounced the “Castle in the air” theory back in 1936.

It analyzes how the crowd of investors will behave in future, stock valuation is based on optimism and investors tend to build their hopes into castles in the air. That applied to the dotcom craze, it also applies to the current China A-share market.

This week is the “Golden Week” in China, this national holiday lasts for a week and local stock markets are closed. Most Chinese will take a break from watching stock quotation screens and travel to Hong Kong or overseas for vacation trips.

A relative of mine from Guangzhou visited me yesterday in Hong Kong and I took the chance trying to understand first hand the development of the A-share craze. She is a 60 years old house wife, a retired civil servant, never invested in stock market until very recently.

Here are some interesting points:

• People only talk about stocks no matter in restaurants, universities or work place, you can hardly set up business meetings with anyone before 3PM which is the stock market closing time.
  

• They are rushing to open stock trading accounts, though the initial account opening deposit requirement has been increased 10 times from RMB5,000 to RMB50,000. (RMB50,000 is almost the annual salary for an average person in Guangzhou.)
  

• Chinese investors are speculating not only on stocks, but also mutual funds. Most investors think mutual funds are sure win investment because they are managed by ‘professional managers’

Interestingly, my relative knows she is gambling. She said she couldn’t understand why some stocks can keep going up even though they are money losing companies, she kept telling me the market will collapse sooner or later. This can perfectly be explained by the “Castle in the air” theory, everybody is looking for the next bigger fool.

The Chinese castle is developed because of one single reason, foreign investors are prohibited from A-share investment in general except those with QFII (Qualified Foreign Institutional Investor) quota allocation which itself is a scarce resource. Total QFII allocation is less than 1% of the total Chinese market capitalization and hence impact from international institutional investors are negligible.

In fact international investors are becoming more cautious of the A-share craze, one very good indication is the discount/premium demonstrated by the Morgan Stanley China A-share Fund (CAF).

From the chart below we can clearly see that CAF has reverted from its all time high of 15% premium in Dec 2006 into its current discount of 15% and the discount level is still keep increasing. Similar pattern can also be observed from the iShares FTSE/Xinhua A50 China Tracker (IFXAF.PK or 2823.HK).

This is opposed to the uni-directional movement of the Shanghai Index:

It’s hard to tell when will the A-share market correct, but I would say it has to be triggered by Chinese Government’s administrative intervention because all external forces will have no effect in this closed investment environment.

I am unwilling to bet on such timing and I have exited all my positions in CAF.

Disclosure: I have no position in the above mentioned stocks.

Comparison of two China A-share ETFs

As of today there are two ETFs with pure focus on China A-share market. They are Morgan Stanley China A Share Fund (CAF) and iShares FTSE/Xinhua A50 China Tracker (IFXAF.PK or 2823.HK).

Below is a comparison of these 2 ETFs and my personal preference based on the latest development of Chinese government policy.

Listing Location

CAF is US listed denominated in US$, iShares FTSE/Xinhua A50 China Tracker is HK listed denominated in HK$ (2823.HK) and traded as pink sheet in US (IFXAF.PK).

Index Fund/ Actively Managed Fund

IFXAF is a passive index tracking fund, the Fund's objective is to track the performance of the FTSE/Xinhua China A50 Index. The Fund invests in Chinese A-Shares Access Product (CAAPs) issued by a connected person of QFII as underlying investments.

CAF is actively managed and invest directly in Chinese A-share with its allocated QFII (Qualified Foreign Institutional Investor) quota, its fund manager is supposed to exercise his strategy to pick stocks to beat the index.

Fund NAV (as of 14 March 2007)

IFXAF: HK$18.1B (or US$2.3B)

CAF: US$421M

Top 10 Holdings (as of latest report)

CAF

Out of its top-10, 19% of the fund is invested in bank/finance sector.

A-50

Out of its top-10, 28.2% of the fund is invested in bank/finance sector.

Sector Breakdown

CAF

A-50

We can see that CAF overweighted industrial sector while the A50 index is more banking and finance biased.

Discount/Premium (as of last closing)

IFXAF: 7.16% discount to NAV

CAF: 12.44% discount to NAV

Most recent discount/premium can be checked from the following sites:

CAF

http://www.etfconnect.com/select/fundpages/global.asp?MFID=168692

IFXAF:

http://www.ishares.com.hk/ishareshk-cgi-bin/funds.pl

After reading all the factual information, here is my further analysis based on the current Chinese political and economical situation.

I am very bullish towards China’s general economic and stock market growth, at least towards the end of 2008 when the first Olympics is being hosted by China. ‘Face’ is one of the main reasons why China would support the market till then. Secondly, the CSRC (China Securities Regulatory Commission) has already announced the plan to accept HK listed Red Chips to return home and list as A-share in Shanghai Stock Exchange. In fact according to news source from China, China Mobile (CHL) has already submitted such application this week. This is in addition to the H-share return home which has already started and will see more on an ongoing basis. China Life (CHL) is one of the H-share just returned home recently.

What is the implication of the ‘return home’ of Hong Kong listed Chinese stocks? As in any market index, the criteria of selecting constituent stocks is to pick the most representative companies in each sector with high trading liquidity. In the past there are very few such companies listed in Shanghai/Shenzhen, not because those companies didn’t exist, rather they have chosen to list overseas (mainly in Hong Kong) because of the previously underdeveloped stock market in China. Now those return home companies will undeniably become a strong catalyst to the Chinese stock market because investors are more willing to re-allocate their money from low interest saving accounts to stock market now filled with profitable industry leading giants.

At the same time those original A-50 smaller constituents less profitable companies will be kicked out from the index. This process will go on until there are no more companies need to be reshuffled from the index, this will take at least a few years and this is exactly a period during which the A-50 will experience the highest growth rate.

So the next question is whether CAF can beat the A-50 index?

Previosly I don’t have preference among the two, until CAF disclosed its full portfolio recently. I reviewed the latest CAF annual report and its full portfolio. I am not too pleased with what I see.

CAF has invested around 5% of its money into 11 funds (including the iShare A-50 fund!). I really cannot understand the reason for doing so when there are a whole lot of available alternative companies in the Chinese market. So practically 5% of CAF is a Fund of Funds. This raised a question whether the CAF manager has really tried his best effort to increase the return, may be a sign of agency problem. Though 5% of the NAV is not a significant amount, I always believe minor issue can help us uncover bigger truth.

CAF investment in other Funds

There are a lot of research papers which show most active funds cannot beat the index, unless there are strong evidences to convince me an actively managed fund is better than the comparable index fund, I would rather play safe, especially in this case the A-50 index is so rosy. I am in favor of iShares FTSE/Xinhua A50 China Tracker (IFXAF.PK or 2823.HK).

Disclosure of interest: I have a LONG position in 2823.HK

香港散戶投資中國A股的3個途徑

今天適逢大跌市，有朋友想趁低價買入 iShares FTSE/Xinhua A50 China Tracker (2823, HK listed)，他曾經看過我的網站介紹過Morgan Stanley China A Share Fund (CAF)，今天一早便打電話來問我CAF跟 2823 有甚麼分別，我想藉此機會跟大家介紹一下這兩ETF (Exchange Traded Fund) 的分別。

上市地點

CAF 是在美國上市的一隻封閉式基金 (Closed End Fund)，你需要有美國股票戶口才可進行買賣。而 2823 A-50 卻是在香港上市的一隻指數基金，只要你有港股股票戶口便可進行買賣，跟其他港股買賣沒有分別。不要覺得買賣美國股票很麻煩，其實香港很多銀行都以提供此服務，另外，美國的ETrade 及 Charles Schwab 已在香港設立辦事處，開戶口也十分簡單。對於經常買賣美股的人，ETrade 及 Charles Schwab 的佣金收費比較便宜。


主動式/被動式 管理基金

2823是Barclays Global Investors在香港發行以新華富時A-50指數為基礎的一隻基金股票，基金的表現是緊貼該指數的走勢 (並不是百分之一百緊貼，基金在操作上有所謂 index tracking error存在)。

亦因為他的表現緊貼指數，基金經理的工作只需要根據指數五十隻在上海及深圳上市的成分股比重作出調整，如果指數沒有發生什麼變化，基金經理便不需要作任何調整。

所以這類基金亦稱之為被動式基金(passively managed fund)。A-50其實沒有QFII quota，他使用derivative工具(Chinese A-Shares Access Products)去對A股進行投資，詳情我不在這裏解釋了。

相對地CAF是一隻主動式基金，基金經理的工作便是把基金投資在他自己心目中覺得有潛質的股份，在選股時有一定的規條，這些規條在上市文件中已經詳細列明。

那麼主動式或被動式基金的表現會比較好呢？理論上，基金經理應該有他的獨特投資觀點，應該選股時可以選擇一些比較出色的股票去提升投資組合的回報(相對於指數)。但是實際上，世界上很多學者曾經做過多方面的研究，答案是，大多數基金經理的表現都不能超出被動指數基金。這裏是其中一個研究報告。

現在讓我們看看這兩隻基金所持的成分股票：

CAF Top 10 Holdings

2823 A-50 Top 10 Holdings

可以看到他們Top 10的成分非常不同。再看看他們在行業選擇(sector)方面是如何的不同：

CAF

A-50 Sector

從這裏也可以看到他們在行業上的持股量亦是非常不同，CAF比較偏重工業股，A50指數比較偏重銀行股。

再看看他們過去三個月的相對表現：

可預見到2823的表現也是比較好。(由於CAF是大概在去年１２月才fully invest, 所以我選擇了三個月的表現來作比較)

Discount/Premium

由於是封閉式基金(Closed End Fund)，基金IPO之後便不會再接受新的認購，買賣只可以在二手市場進行，亦因此基金價格會受到供求關係所影響，即是說當投資者看好這一隻股票基金引致大量需求時，股價便會相對於資產價值高(premium)，相反地，當投資者不看好這隻基金前景時，由於需求減低，基金股價便低於資產價值而產生折扣(discount)。

當基金呈現折扣時，是不是等於這隻基金很抵買呢？答案是不一定，請看看下圖一隻韓國基金的表現：

KF

我們可以看到，這隻基金是長時間呈現折扣，所以折扣並不代表一定是抵買。

怎樣可以查出他們的discount/premium呢？可參考以下網站:

CAF

http://www.etfconnect.com/select/fundpages/global.asp?MFID=168692

2823 A-50:

http://www.ishares.com.hk/ishareshk-cgi-bin/funds.pl

稅務

CAF是會每年派息的，如果你不是美國人，美國政府會扣除股息的30%withholding tax。對香港投資者來說，這也是需要考慮的重點之一。 2823 A-50因為是港股，這方面是免稅的。

結論

在未來兩至三年，我是整體看好A股市場的表現，再加上最近中國証監處宣布香港紅籌股及H股回歸中國作A股上市，這即是說，越來越多高質素的公司將會成為A股的成分股，同時間把低質素的公司踢出指數外，只要這些高質素公司的表現及盈利越來越好，A股票指數便會不斷上升。這現象就等如恆生指數在香港市場過往的表現一樣。長期方向只會不斷向上升。

相反地，主動式基金(CAF)未必在選股時有優勢。

另外，我剛剛看個CAF的annual report及他整個portfolio composition，發現他把大概5%的資金買了包括A-50基金在內的一些基金，換句話說，5%的CAF是一隻fund of funds。我對他這個做法相當不滿，在中國A股市場那麼多選擇，為什麼要把基金投放在其他的基金，不要忘記我們每年需要付management fee的(management fee是只動會從NAV裏扣減)！

Table Showing 5% of CAF is Fund of Funds !!

基於以上兩個原因，我比較看好A-50。

其實還有第三過投資A股的途徑，便是JF所出的JF CHINA PIONEER A-SHARE FUND – A，不過由於這隻基金已經fully subscribe，直至它能夠拿到新的QFII之前，不接受新的認購，所以我在這裏不作介紹了。