Institutionalisation of China’s stock markets, MSCI inclusion, and potential CDR relisting are positive for A shares. Post the SDR inclusion of the renminbi, the scrapping of Sino-Foreign JV requirements for foreign asset managers to raise China AUM, and accelerated IPOs are positive results from China’s on-going financial reform. The China-Hong Kong stock connect program attracted both mainland and international investors’ participation in 2017 and MSCI inclusion and potential A-share CDR relisting are catalysts for stronger Sino-foreign inter-connectivity in 2018. CLSA is optimistic about the long-term outlook for China’s A-share market.
China is connecting with the world Southbound inflows are stickier than northbound but monthly turnover may dip 50-70% due to seasonality, and a late Chinese New Year points to a delayed recovery. Higher mainland domestic consensus could lead to volatility due to differing expectations. We provide a list of stocks where the risk-reward is negative/positive based on funds flow, consensus differentials and southbound momentum.
Institutionalisation in play: Mainland stock market’s market capitalization exceeded Rmb55trn by the end of 2017. Driven by growing wealth effect, China’s assets under management (AUM) via mutual funds and private fund management grew 30% YoY in 2017, indicating higher institutional adoption. Apart from the previous QFII (Qualified Foreign Institutional Investor) model, foreign asset managers can raise renminbi AUM by setting up their wholly foreign-owned-entity private fund-management (WFOE-PFM) entities onshore. Foreign asset-management companies (AMCs) will contribute to A-share institutionalization and we expect no less than 20 foreign AMCs by the end of 2018.
Preparing for MSCI inclusion: China is preparing for MSCI inclusion in 2018. Besides accelerating the number of domestic IPOs (at an historical high), regulators also fast-tracked the backdoor listings of technology companies previously listed in the US stock market to be relisted in domestic A-shares in 2017. The intention to relist more US listed Chinternets into A-share via the China Depository Receipts (CDR) is made clear and the regulatory framework should be finalized in 2018. All eyes will be focused on the MSCI inclusion, and potential Chinternets inclusion into the benchmarked indexes.
Global interest in China via northbound. Northbound traffic is growing, with turnover and accumulated inflows exceeding Rmb2tn and Rmb200bn in 2017. The daily quota for stock connect trading turnover will be enlarged by four times, effective 1 May 2018, as regulators prepare for a higher degree of global participation in the domestic A-shares. CLSA forecasts northbound inflows to double to Rmb400bn by 2020, driven mainly by 200+ A-shares to be included into the MSCI indexes in 2018. Potential CDR relisting in Shanghai could be an additional reason for global investors to participate in the mainland stock market opportunities.
China interest via southbound move. Aggregate southbound inflow into the Hong Kong stock market has already exceeded HK$800tn to date. About 55% of accumulated inflows targeted dual-listed equities are trading at big H/A discounts, while the remaining 45% target HK-only equities with global business outside of mainland China. Besides more domestic institutional investors using the stock connect program to diversify their portfolios, mainland retail-investors participation also supported the robust growth in stock connect turnover and inflows in 2017. Higher retail-participation could create market volatility in 2018-2019.
Negative/positive risk-reward. Stock connect is disruptive, especially when mainland retail investors have different sets of expectations and sector preferences. We analyse datapoints on funds flow (percentage of connect holdings), consensus differentials (domestic vs international) and stock connect momentum (trend of connect holdings) for the 2000 A/H eligible equites to identify on-going changes in expectations to determine potential risks and rewards. Monthly trade data and consensus upgrades/downgrades will help determine potential flow momentum, northbound and southbound.