Investors eye quick gains from HK-Shanghai exchange tie-up

It took slightly more than 10 minutes for international investors to plough more than $1bn into the Shanghai equity market on Monday morning, as a new trading scheme began to reshape the way the world interacts with China's financial markets.

The Shanghai-Hong Kong Stock Connect has not just attracted cash, but also towering rhetoric. Charles Li, chief executive of the Hong Kong stock exchange, described the new market opening as a "historic moment" that would "redefine Hong Kong".

International investors are now busy seeking out ways to profit from the scheme, which finally gives them direct access to one of the world's largest capital markets without the need for an investment license.

With a market capitalisation of more than $3tn, the Shanghai Composite index outstrips both the Nikkei 225 and the FTSE 100 in terms of size. Dominated by retail investors, it also has one of the highest daily turnovers of any equity market.

By comparison, the initial size of the Stock Connect is relatively small. Each day, up to Rmb13bn ($2.1bn) can head north into China from Hong Kong, while a maximum of Rmb10.5bn can go south. Aggregate quotas also limit the total amount that can be held across the border in both directions.

Mainland analysts have downplayed the immediate impact the scheme will have on sentiment in the Shanghai market, in spite of the injection of fresh international capital. At lunchtime on Monday, the main Shanghai index was up about 0.7 per cent.

"China is proceeding with reform in a step-by-step fashion. This programme won't cause major market fluctuations in the short term. The economy will be the main driver of the market," said Gui Jiang, founder of Simpleway Asset Management in Shanghai.

Bankers in Hong Kong say that take up in the early days will largely be limited to those who know China well already, particularly hedge funds and retail investors, while large institutional investors - though keen on the scheme - will take a more gradual approach.

The Shanghai market presents first-time investors with a range of challenges, such as the lack of English-language research, a complex regulatory environment, and a completely different market structure with few large long-only investors.

"If you're not familiar with Chinese stock markets it can be like stepping in to play the All Blacks without understanding all the rules of rugby," said Barnaby Nelson, in charge of sales to financial institutions in Standard Chartered's Transaction Bank in Hong Kong. "The market velocity is such that it's a market where you can go a long way wrong in a short space of time."

Even so, the Stock Connect has already left its mark on both sides of the border. Dozens of dual-listed stocks have seen price gaps disappear as investors look to capitalise on long-standing discrepancies caused by the lack of mutual market access.

The Hang Seng AH Premium Index - a gauge of price differentials between Hong Kong and Shanghai - now stands at 102 , up from 95 when the link was first announced. A number above 100 indicates that mainland shares trade at a premium to their Hong Kong equivalents.

Anhui Conch Cement's Hong Kong listing has dropped 12 per cent since the Stock Connect was announced six months ago, while its Shanghai share price has risen 8 per cent. Bank of China has added 8 per cent in Hong Kong, but 15 per cent in Shanghai.

Aside from trading the price arbitrage, sell-side analysts have tipped a number of sectors as near-term plays on the Stock Connect, such as consumer discretionary and healthcare stocks listed in the mainland. The two sectors combined account for 18 per cent of the domestic share market, compared with just 6 per cent in Hong Kong.

Thanks to the flow of money heading out of China, HSBC's equity analyst Steven Sun also expects the "scarcity trade" to lift Hong Kong-listed shares in areas unrepresented in the Shanghai market.

His recommendations include casino stocks such as Galaxy Entertainment and Sands China, insurer AIA, and distressed debt manager Cinda Asset Management - all of which have rallied by at least 10 per cent in the past month.

For similar reasons, JPMorgan has picked out Hong Kong conglomerates and Chinese technology stocks as potential winners. Tencent and China Mobile - two of the mainland's largest companies - both become accessible to mainland investors for the first time through the Stock Connect.

Additional reporting by Jennifer Hughes in Hong Kong and Gabriel Wildau in Shanghai

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