China Optimism Prompts Record Inflows Into Hong Kong Stock ETFs

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An unprecedented amount of money is flowing into the largest exchange-traded funds that track Chinese companies listed in Hong Kong as investors bet the biggest rally in more than three years will continue.

The Hang Seng H-Share Index Fund lured HK$20.5 billion ($2.6 billion) in April, the largest monthly inflow since at least 2010 and the third-most among equity ETFs globally, according to data compiled by Bloomberg. About HK$29 billion has been added to the fund during the past four months in the longest stretch since 2013 as assets grew to HK$57.1 billion.

Chinese companies trading in Hong Kong will narrow the discount to their dual-listed counterparts on the mainland as the rally spreads to the so-called H-shares market amid expectations for more monetary easing in the world’s second-largest economy, according to UBS AG. While the Hang Seng China Enterprises Index soared 17 percent in April, the most since October 2011, A shares in China are still trading at a 31 percent premium to stocks in Hong Kong.

“The H-share market still has room to go higher based on momentum and liquidity with the monetary easing measures,” Jorge Mariscal, chief investment officer for emerging markets at UBS in New York, said in a phone interview. “That valuation gap between A and H shares is going to close. Investors are expecting the monetary easing will continue, and the economy will stabilize down the road.”

Rate Cuts

The Hang Seng China Enterprises benchmark has climbed 48 percent in the past year compared with a 119 percent advance in the Shanghai Composite Index’s A shares. Both gauges ended last week near seven-year highs. A Bloomberg index of the most-traded Chinese stocks in the U.S. rose 0.5 percent on Friday, paring a weekly loss to 1.5 percent, on a day when markets in China were closed for a holiday. The H-shares gauge fell 0.1 percent on Monday after a manufacturing index weakened last month.

Mainland stocks have rallied as investors took advantage of the Shanghai-Hong Kong exchange link and low valuations while anticipating the beginning of looser monetary policy. The People’s Bank of China cut interest rates and reduced banks’ reserve requirement ratios twice in the past six months in an attempt to prevent a deeper slowdown as the economy is forecast to expand 7 percent this year, the weakest pace since 1990.

Record Inflow

The MSCI China Index ETF also attracted record inflows in April as investors added HK$1.2 billion, the most since the HK$4.1 billion H-shares fund began trading in Hong Kong in 2001. U.S. investors also boosted their H-share positions through the iShares China Large-Cap ETF which grew by $385 million in April, the biggest inflow in eight months.

The Hang Seng H-Share ETF rose 17 percent in April to HK$145.20 in a third month of gains while the MSCI China fund surged 16 percent to HK$26.90. The iShares China Large-Cap ETF also jumped 16 percent last month in New York. It rose 0.9 percent to $51.80 on Friday.

The Hang Seng H-share measure, which mainly includes China’s big state-owned companies, is valued at about 10 times forward earnings. That compares with a multiple on the Shanghai Composite Index of 17, up from 7.5 a year ago, data compiled by Bloomberg showed.

China’s stock markets may be vulnerable to a pullback in the near future, even amid an extended rally, as the underlying economy catches up with equity prices, according to Michelle Gibley of Charles Schwab Corp.

‘Too Fast’

“Chinese stocks may have moved too far, too fast in the short term, but may potentially be early in a longer term move higher,” Gibley, the director of international research at San Francisco-based Charles Schwab, wrote by e-mail. “Typically during a shift in monetary policy, valuations expand first, then fundamentals.”

While China’s official Purchasing Managers’ Index, based on surveys of larger manufacturers, stayed at 50.1 in April, the preliminary reading of another PMI from HSBC Holdings Plc and Markit Economics for smaller businesses slid to a one-year low of 49.2. A reading above 50 indicates expansion.

Premier Li Keqiang said in March that the nation will roll out more measures to support growth if employment is at risk. The state council announced more tax breaks and subsidies to some enterprises to support job creation last month.

“The central bank is taking measures to boost the economy by providing support through the policy banks, who lend to the large state-owned enterprises,” Clem Miller, an investment strategist at Wilmington Trust, which manages $80 billion, said by e-mail. “The shares of these enterprises dominate the H-shares market, and investors expect these shares to appreciate.”