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.

It's been a good few months for Hong Kong stocks, which have rebounded by almost a third from their February lows. Once the current spate of global jitters over central bank policies has subsided, there are reasons to expect the recovery to persist. The latest cause for optimism: Chinese insurers.

Mainland insurance companies are now allowed to buy the city's shares through an exchange trading link with Shanghai, the China Insurance Regulatory Commission Stocks said last week. Officials had already dropped a quota on the amount of Hong Kong stocks investors can buy through the trading channel (though daily limits still apply).

The impact may be significant. The opening of the new investment channel may lead to as much as 100 billion yuan ($15 billion) flowing into Hong Kong stocks in the next two to three years, Deutsche Bank estimates. Citigroup forecasts insurance inflows of $700 million a month.

China's insurance companies are hard-pressed to find sufficient investment outlets at home and have been piling into alternative assets such as real estate this year in search of higher returns. Hong Kong equities have two key attractions: They trade at a discount to shares on China's domestic exchanges, and they are denominated in the Hong Kong dollar, which is pegged to the U.S. currency and therefore offers a hedge against a weakening yuan.

The start of the so-called Hong Kong-Shanghai Connect in late 2014 fostered speculation that the valuation gap between dual-listed shares would be eliminated. While that has yet to happen, the difference has narrowed this year amid evidence of increasing Chinese interest in Hong Kong stocks. Until Aug. 17, when the investment quota was scrapped, flows from Shanghai into Hong Kong typically outweighed those going in the other direction. Citigroup estimates that so far this year, inflows into Hong Kong have reached $2 billion a month, compared with $500 million in outflows.

Falling Premium
A rebound in the benchmark Hang Seng Index has narrowed the Hong Kong-China valuation gap
Source: Bloomberg

Chinese insurers are allowed to invest 15 percent of their total assets overseas and as much as 30 percent of their total assets in equities. While firms such as Anbang have been on an overseas buying spree recently, that still leaves plenty of room. China Life, the largest insurer, said last month it had allocated 7.45 billion yuan to Hong Kong's so-called H shares (mainland-incorporated companies that trade on the city's stock exchange), or about 2.8 percent of its total investment in stocks and mutual funds, according to Chinese brokerage CICC.

Only about 13 percent of the 12.6 trillion yuan invested by Chinese insurers was in equities as of July, with overseas assets accounting for less than 2 percent, according to Goldman Sachs estimates.

Room to Grow
Chinese insurers can invest a maximum of 15 percent of total assets overseas and 30 percent in equities
Sources: China Insurance Regulatory Commission; Goldman Sachs
Note: Goldman Sachs estimate of overseas investments is for full year 2015; estimate of equity investments is for July 2016.

Until they were allowed to use the Shanghai Connect, Chinese insurers were able to buy Hong Kong stocks via the qualified domestic institutional investor channel. However, no new quotas have been handed out for that program since a $90 billion cap was reached in April 2015, according to Deutsche Bank.

With China having cut interest rates six times since late 2014, it's become more difficult for insurers to fund their liabilities through investments at home. That increases the likelihood of money flowing into Hong Kong. Rational insurers with a bulk of their books in protection-type instruments are likely to target higher dividend-paying stocks and blue chips. Higher-risk insurers with a bulk of their policies in short-duration universal life policies that promise generous returns are likely to be drawn to more speculative shares.

Either way, it looks like there's a rush coming.

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