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 !

Lets Think China Discussion Group

Dear "Lets Think China" readers,

Thanks for your interest in my blog. I've created a discussion group for idea exchange on any China stock/fund/ETF/ADR related opportunities.

If you are interested to exchange ideas with me and other members, just follow this link to join us !

Thanks and I look forward to seeing you in the Group!

Best Regards,

Siwei Zhong