Now that you can, should you buy Shang­hai?

Financial Mirror (Cyprus) - - FRONT PAGE -

After years of frus­tra­tion, months of spec­u­la­tion and re­peated as­ser­tions that ‘there is no firm timetable,’ the world’s big­gest in­ac­ces­si­ble stock mar­ket is fi­nally open­ing up to for­eign in­vest­ment. From Mon­day, the Shang­hai-Hong Kong Stock Con­nect pro­gramme will al­low in­ter­na­tional in­vestors to buy and sell around 560 of the largest A-shares listed in Shang­hai di­rectly through their Hong Kong bro­ker, with­out all the has­sle of com­ply­ing with ex­ist­ing QFII and RQFII in­sti­tu­tional quo­tas. The long term po­ten­tial of this move is huge for both sides - to­gether Hong Kong and Shang­hai leapfrog the London Stock Ex­change, Euronext and Tokyo to take the num­ber three spot in terms of cap­i­tal­i­sa­tion. But for now the ques­tion fac­ing in­vestors is a sim­ple one: Now that I can invest, should I?

We re­cently looked at val­u­a­tions in Shang­hai, and con­cluded that the mar­ket con­tains far fewer bar­gains than its ag­gre­gate P/E ra­tio of 11.5 would sug­gest. Like many emerg­ing mar­ket ex­changes (Korea and Brazil for ex­am­ple), Shang­hai is dom­i­nated by a hand­ful of large firms-most no­tably the big four banks, which make up 20% of the mar­ket’s cap­i­tal­i­sa­tion and con­trib­ute 40% of its earn­ings. The rock­bot­tom val­u­a­tions of th­ese in­sti­tu­tion­swhich may be fully jus­ti­fied, de­pend­ing on the true ra­tio of bad loans on their bal­ance sheets- drag down the ag­gre­gate to a huge de­gree. In fact the mar­ket cap-weighted P/E for stocks in the group of 560 which the Shang­hai-Hong Kong Con­nect scheme will open up is around 20, com­pa­ra­ble with Ja­pan.

Yet for many clients, the ques­tion is not whether to al­lo­cate to China, but how to do so. Specif­i­cally, what are the rel­a­tive ad­van­tages of A-shares over H-shares (main­land com­pa­nies listed in Hong Kong) now that the for­mer are freely ac­ces­si­ble for the first time? The an­swer de­pends on the na­ture of your China play.

If Shang­hai’s in­dexes are strongly in­flu­enced by the fi­nan­cial sec­tor, Hong Kong’s are to­tally dom­i­nated by it. Fi­nan­cial and en­ergy firms make up 80% of H-shares by mar­ket cap­i­tal­i­sa­tion, with in­dus­tri­als bring­ing the to­tal up to almost 90%. Con­sumer, health­care and IT firms, mean­while, make up a tiny 6% of the Hshare mar­ket. In Shang­hai, fi­nan­cials and en­ergy firms con­sti­tute a lit­tle less than 60% of the mar­ket, with con­sumer, health­care and IT firms car­ry­ing more than twice as much weight as in Hong Kong at 16%. But while Shang­hai of­fers the op­por­tu­nity to invest in a wider spec­trum of mar­ket sec­tors, what it does not of­fer is a bar­gain. Across all sec­tors ex­cept con­sumer dis­cre­tionary, Ashares are more ex­pen­sive on a mar­ket-cap weighted ba­sis than the equiv­a­lent H-share sec­tor in Hong Kong.

So, in­vestors with strong con­vic­tions about the rise of the Chi­nese con­sumer may well want to take a hard look at Shang­hai, both for in­di­vid­ual op­por­tu­ni­ties and for a de­gree of di­ver­si­fi­ca­tion which sim­ply does not ex­ist in the H-share uni­verse. How­ever, in­vestors whose views on China fall into a broader ‘growth will do fine, the banks will sort them­selves out with min­i­mal pain, real es­tate will re­cover and re­forms will pro­ceed nicely’ cat­e­gory, will prob­a­bly want to stick to the deeply dis­counted bank and de­vel­oper plays on of­fer in the H-share mar­ket.

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