China A-H share premiums

[abrakaa]

If any of you are in the HK equity space, would appreciate your thoughts on the China A-share versus H-share premium.



China A-share valuations are hovering at the lowest levels seen in years while foreign institutional money continues piling into H-shares and HK-listed A-share ETFs, pushing the premium over NAV in these to above 10%. In my opinion there are two possibilities: (1) Chinese domestic investors have not properly responded to international sentiment, and once Chinese govt releases more QFII, Chinese stocks will rally by 10% to catch up with H-shares (2) Foreign investors are less likely to understand Chinese markets, and are overvaluing H-shares because they are pricing them against broader equity index correlations that are no longer valid. Even if QFII is released, foreign investors will not be able to push up Chinese stocks.



Which of these (or perhaps other possibilities) do you think are likely?

[dantes]

Historically A shares have traded with huge premiums over H and the answer is none of the above. This is one of the best examples of two markets for the same asset with almost totally different sets of investors. There is currently nothing that would force these prices in line with each other, as they are not fungible in any way. If A and H trade in line its a fluke, more or less.

[kapital]

What Dantes said. A-share/H-share premium/discount doesn't mean much. A-shares trade in a closed market. QFII quotas are being given out but it is at a certain pace and certain size (small relative to the market).



I dont think it's worth spending much time on pondering the effect of the government suddenly opening the QFII pipeline. Of course it would send A-shares into orbit vs H-shares and everything else. But that's not kind of thing government wants to do while it's preoccupied with trying to control its real estate bubble. But if you do think it's likely soon, then just buy one of these ETFs or the HSI or whatever China related and forget about relative valuations because you'll make enough money not to care about the details.



But back to the A-share ETF NAV premium:



The way I understand it, iShares CSI 300 and FTSE/Xinhua A50 ETFs are priced in HKD but hold RMB backed assets (CAAPs) that are marked to market in USD. Unlike domestic A-share traders buying in the cash market, foreign buyers of these ETFs get exposure to a couple of different risks - A-shares equity performance, RMB/USD, HKD/USD, counterparty risk, and QFII tax and regulation risk. Of these, you can only really *effectively* hedge one of them 1:1. So it seems like the NAV premium/discount has a lot more going on than just reconciling Chinese domestic and foreign investor sentiment. I think for example an anticipated +10% move in RMB vs USD could cause the NAV premium without conflicting foreign and domestic investor sentiment.



(edited to fix a couple of typos)

[abrakaa]

But the underlying stocks pay the same dividends, right? During the big bull markets of 2007 when A-shares were massively outperforming, the ETF traded at a steep discount also. To me that makes sense because why would a foreigner want to own the ETF when it can achieve 2.5x the dividend yield by owning the H-share.



I've been told by some who are closer to this market than I am that there are people out there who will trade 2823 against HSCEI futures and that when the underlying indices diverge, the premium in 2823 moves accordingly.



I would say that USDCNY is quite hedge-able though since it is probably one of the most liquid NDFs out there.

[dantes]

it does not matter if the dividend are the same, that does not force the two stocks to trade in line, only the possibility of arbitrage would do that. For sure there is correlation and that is what people take advantage of when they trade the China ETF vs the H-shares future. Your argument seems to be based on the idea that stock markets will somehow magically value things "correctly" so if the dividend streams and underlying equity value are the same the market should produce equal value on the two stocks. That is never the case in the absence of arbitrage (there are examples of this in other markets as well). For the same reason its not enough that you can hedge RMB through NFDs.

[kapital]

> I would say that USDCNY is quite hedge-able though since it is probably one of the most liquid NDFs out there.



Sorry, I wasn't very clear. (And "one of" was a mistake. I originally had RMB/HKD but split it out and didn't change the next sentence to match.)



My point was if retail traders want to use this as an RMB play and are happy bidding it over NAV with the idea that the supply is maxed (or very slow to grow), then there isn't any acceptable trade to take advantage of it and force it back in line. And in that hypothetical example there need not necessarily be conflict between domestic and foreign investors A-share level view.



FWIW, I don't personally think currency is the majority part of your 10% premium here though. I think it is what it is on the face of it - foreigners simply having more interest to get a ticket to ride A-shares in a time where the Chinese government is tightening the issuance of QFII quotas. And, I think it says as much or more about government control than it does about differing opinions of domestic/foreign investors that will ultimately need to be reconciled.



>I've been told ... that there are people out there who will trade 2823 against HSCEI futures and that when the underlying indices diverge, the premium in 2823 moves accordingly.



To the extent there are many people putting on those trades there would be an effect I'm sure. But, I have known a lot of people to take a look at that trade and pass on it so I'm not sure how much impact from those trades you are seeing there.



> But the underlying stocks pay the same dividends, right? During the big bull markets of 2007...



I don't think dividend yield was playing much more than a bit part in the H and A share markets in 2007.

[abrakaa]

Sure I hear what you guys are saying and I'm not claiming there is a strong arbitrage or mean-reversion mechanism on a intraday or even intra-week basis between an H-share and its A-share. There are dozens of examples of large cap stocks which continue to exhibit massive divergence. Nonetheless, I don't think it is a coincidence that QFII-accessed A-share product premiums spiked up at the same time as the broad A-share collapse toward end of May, which also coincided with new lows in A-H share premium. In other words I see the under-performance of A-shares as the core reason for the emergence of double digit premiums in A-shares ETFs. To talk about tightening QFII quota is sort of describing an effect of market demand rather than its root cause (obviously quota is tight, since everyone is buying A-share ETFs and therefore everyone does creation until there is no quota left). I'm interested in other ideas for why this premium would happen now and how long it might last for.

[kapital]

>Nonetheless, I don't think it is a coincidence that QFII-accessed A-share product premiums spiked up at the same time as the broad A-share collapse toward end of May, which also coincided with new lows in A-H share premium. In other words I see the under-performance of A-shares as the core reason for the emergence of double digit premiums in A-shares ETFs.



What year are you talking about? This year? And under-performance of A-shares vs what? HSCEI?