Markets

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Buy on rumor, sell on fact? China has given its blessing to a pipe that links the stock exchanges of Shenzhen and Hong Kong, opening the nation's market further to foreign investors and allowing more funds to flow in the opposite direction. Anyone hoping the news will juice a rally in Chinese shares may be disappointed, though.

The trading link was approved by the State Council, China's cabinet, according to a statement posted on the government's website after markets closed on Tuesday. The  arrangement will begin in about four months.

History suggests that anticipation of such cross-border channels carries more punch than the reality. The CSI 300 Index, which tracks stocks traded in Shanghai and Shenzhen, added 5 percent through Friday and Monday, the biggest two-day gain in more than five months, on speculation an announcement was imminent. Having slipped before the news on Tuesday, stocks may be in for another bounce. However, the longer-term impact is likely to disappoint.

Similar bouts of frenzied rumor and speculation attended the introduction of a bridge between the Hong Kong and Shanghai exchanges two years ago. When the link finally went into operation, in November 2014, the experience was underwhelming, with daily investment quotas frequently going unfilled.

Disconnect
Investors in Hong Kong have used barely half of the aggregate quota for buying Shanghai stocks
Source: Bloomberg

Optimists may argue that the Shenzhen connect will be different. The southern city, which borders semi-autonomous Hong Kong, is generally home to smaller and younger companies than Shanghai, which hosts most of China's giant state-controlled industrial enterprises. Shenzhen's preponderance of consumer and technology companies may hold more appeal to international investors than the old-economy stalwarts that dominate the Shanghai exchange.

Shenzhen-traded companies include Midea Group, the consumer electronics manufacturer that's buying German robot maker Kuka; spirits maker Wuliangye; and electric-car developer Gree Electric Appliances. Such stocks are currently off limits to foreign investors unless they have access through arrangements such as the qualified foreign institutional investor program. Shenzhen is also home to the racy, Nasdaq-like technology board ChiNext, though that market won't be included in the initial stage of the link. 

Such a different investment mix may hold allure for investors in Hong Kong. Still, whether interest will be sufficient to avoid the imbalance seen in the Shanghai program is doubtful.

The uncomfortable fact is that too many mainland investors want out. Inflows into Hong Kong through the Shanghai connect overtook those going the other way in January for the first time since the link started and have largely stayed that way. As of Tuesday, barely half of the 300 billion yuan ($45 billion) aggregate limit on northbound flows into Shanghai had been used. More than 80 percent of the 250 billion yuan southbound quota had been taken up. Helped by this stream of buying, Hong Kong's benchmark Hang Seng Index has risen 4.6 percent this year, while the Shanghai Composite Index has lost 12 percent.

Hong Kong Lure
Stocks on the Hang Seng have handed investors more handsome returns this year

Hong Kong's attraction lies partly in the availability of stocks such as Internet behemoth Tencent and global banking group HSBC, which aren't traded in mainland China. Companies that trade in both markets are generally cheaper in the former British colony. Buying equities in Hong Kong, whose currency is pegged to the dollar, also serves as a hedge against a weakening yuan. 

Costly China Stocks
China shares still trade at a premium to their Hong Kong counterparts
Source: HSI Services Limited
Note: Hang Seng China AH Premium index tracks the price premium (or discount) of A-shares to H-shares. The higher the index, the higher premium of A-shares over H-shares, and vice-versa. Base = 100 Ticker tracks price feed only.

For now at least, it's hard to see how the trading funnel to Shenzhen will reverse Hong Kong's gravitational pull for Chinese investors. The State Council has declared the Shenzhen connect a reality; its fruits are likely to remain a pipe dream.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net