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

Tencent (TCEHF.PK or 0700.HK) Founder Pony Ma Named as “Builders and Titans” by TIME magazine

This week is a great week for Tencent, the most popular instant messaging service provider in China, not only because it is included to the MSCI Hong Kong index (effective end of May), but also its founder Pony Ma is being elected as a member of the TIME 100 list of men and women whose power, talent or moral example is transforming the world.

Market reacted very positively in Hong Kong, the stock (TCEHF.PK or 0700.HK) jumped almost 10% to HK$32.5 in the first 15 minutes, and still gained 3% at HK$30 when market closed.

In my previous discussion on this stock on 22 March I said “Share price dropped by more than 5% today because of a CITI downgrade from BUY to HOLD saying the share price has already appreciated by 20% since Jan and investor shall look for more attractive entry point. I don't agree with CITI's report and I see this as a good buying opportunity. I've increased my existing LONG position at HK$26.2 today.”

I am fortunate that I hold up to my own conviction and ignored the CITI analyst report, otherwise I would have missed a good opportunity to increase my holding in this stock. The stock has appreciated 14% since my last recommendation on 22 March.

With a market cap of HK$53B (US$6.8B), I am surprised that there are no derivative products (eg. warrants) available for this stock, otherwise I would rather invest in Tencent’s derivative products with higher leverage for higher potential return. I think this is a very good indication that investors in Hong Kong are not too keen on internet or technology stocks, it may be a mistake when Tencent has chosen Hong Kong rather than Nasdaq for its initial offer.

It’s also an excellent time for investment bankers to pitch Tencent management for a secondary listing in US which can support a much higher PE and can draw a much better attention from institutional investors.

I am still very positive on this company and will keep my long position.

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.