Late to the China Rally, Some Investors See Hong Kong as Way In

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What’s more appealing to global money managers than tapping into China’s world-beating stock rally? Doing it on the cheap.

With surging local demand for Chinese equities sending the Shanghai Composite Index up 108 percent in the past year, mainland shares of dual-listed companies now trade at a 28 percent premium relative to their Hong Kong counterparts, known as H shares.

Foreign investors have caught on, pulling more than $8 billion from exchange-traded funds that track mainland stocks this year while pouring about $4 billion into ETFs that own Chinese companies traded in Hong Kong. With Beijing expanding the types of domestic mutual funds eligible to buy Hong Kong-listed securities and making it easier for traders to wager on declines in mainland shares, the valuation gap should narrow, according to Wells Fargo & Co.’s Derrick Irwin.

“More institutional funds are taking advantage of the pretty significant discount in Hong Kong,” Irwin, who manages the Wells Fargo Advantage Emerging Markets Equity Select Fund, said by phone from Boston. His firm oversees about $352 billion. “The discount will definitely narrow over time as more Chinese investors are able to access the H-share market.”

Record Flows

Among the largest Chinese ETFs last week, the U.S.-traded iShares China Large-Cap fund lured $115 million, the biggest inflow since August, according to data compiled by Bloomberg. The Hang Seng H-Share Index Fund in Hong Kong attracted about $800 million during the five days ended April 17, the most since inception in 2003, as the benchmark index for mainland companies in Hong Kong climbed to a seven-year high.

At the same time, investors pulled a record $93 million from the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF and about $700 million from the Hong Kong-traded iShares FTSE A50 China Index ETF, the most in three months.

The inflows into Hong Kong-listed stocks also came as a 33 percent surge in the Shanghai Composite this year prompted Chinese authorities last week to tighten rules on margin trading and increase the amount of shares available for bearish bets by short sellers.

The measures suggest that while securities regulators are in general “pleased to see the stock market going up,” they may be concerned mainland stocks have surged too fast, Irwin said. Chinese equities have been among the best performers globally this year as policy makers increased monetary stimulus to shore up economic growth.

Stock Premium

Fund flows aren’t signaling a shift in the relative performance of Chinese stocks, according to Matt Lloyd, the chief investment strategist at Advisors Asset Management Inc., which manages $16.8 billion in assets. The domestic A-share market will continue to rally after policy makers last week cut banks’ reserve requirements, he said.

The $7.2 billion iShares China Large-Cap ETF, the largest U.S. fund invested in Hong Kong-listed stocks, rose 2.2 percent to $51.50 in New York on Tuesday, after reaching the highest level since 2008 last week. Deutsche Bank AG’s $1.2 billion fund, the biggest in the U.S. tracking mainland shares, advanced 2.2 percent to a record $47.45.

The Shanghai Composite Index rose 2.4 percent Wednesday versus a 1 percent gain in the Hang Seng China Enterprises Index.

Investors are also using the Shanghai-Hong Kong exchange link to wager on a narrowing valuation gap. Mainland traders have poured 42.9 billion yuan ($6.9 billion) into shares in the former British colony over the past month, while international money managers added less than 3 billion yuan into Shanghai stocks.

“Foreign investors and the locals are doing the same thing right now, Ankur Patel, chief investment officer at R-Squared Macro Management LLC, said by phone from Birmingham, Alabama. ‘‘They are going where the moves are, that is into H shares.’’

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