Photographer: ChinaFotoPress via Getty Images

China Shares' Power Surge Leaves Global Investors Skeptical

  • Biggest China ETFs seeing outflows despite Hong Kong gains
  • MSCI China Index is off to best start of a year since 2012

The biggest equity rally in Asia this year has yet to captivate global investors.

The MSCI China Index, which is dominated by Hong Kong-traded Chinese shares, has surged 11 percent since Dec. 31, its best start to any year since 2012. That’s been fueled by $9 billion of inflows through cross-border trading links as mainland investors seek to diversify from yuan-denominated assets. The enthusiasm hasn’t really extended elsewhere, though, with the two largest U.S. exchange-traded funds tracking Chinese shares seeing outflows in 2017.

The gains in Hong Kong have been at the forefront of a recovery in China’s equities landscape, with the new-found stability spurring a top regulator in Beijing to suggest at the weekend that the market could handle more first-time stock sales. Mainlanders are fueling the H share surge, but ETF investors abroad are trying to work out whether evidence of momentum in Asia’s largest economy warrants that exuberance.

“Global investors in general are still skeptical -- the concern is the buildup of debt in China,” said Ayaz Ebrahim, head of Asia-Pacific asset allocation at JPMorgan Asset Management in Hong Kong. “Outside investors may need to see stronger evidence that China’s economic turnaround is sustainable in the face of an expanding debt burden -- such as better earnings growth -- before they join the rally.”

Setting Priorities

Clues on the Chinese leadership’s approach toward deleveraging and growth targeting may come in a gathering of the national legislature that kicks off March 5.

Liabilities for China’s state-owned enterprises reached 120 percent of gross domestic product at the end of the third quarter, according to Moody’s Investors Service estimates. The International Monetary Fund has also warned of risks associated with China’s rapid expansion of debt. While officials are tightening money-market rates as a way of curbing leverage, aggregate financing in China jumped to a record in January.

Signs of economic strength are mounting, however -- factory prices have been picking up since September, January trade figures beat analysts’ forecasts and manufacturing has stayed in expansion territory.

With capital controls making Hong Kong shares one of the few offshore investments condoned by the government, net purchases of equities traded in the city via the Shanghai stock link have accelerated. The daily average for February is up by 67 percent from the previous three months. The increases “will give a signal to global investors that there’s an underlying domestic demand for Chinese equities, and that’s always healthy,” said Ebrahim.

Recent High

The MSCI China Index dropped 0.5 percent Monday in Hong Kong, still within 2 percent of an 18-month high reached on Feb. 22.

While overall investment in Chinese and Hong Kong equity ETFs has been increasing, according to data compiled by Bloomberg, the biggest vehicles tell a different story. The iShares China Large-Cap ETF and iShares MSCI China ETF have seen $312 million in outflows since Dec. 23, when MSCI’s China gauge hit a five-month low.

For Toshihiko Takamoto, a Singapore-based portfolio manager at Asset Management One, there’s no reason to dive into China when other markets offer better long-term prospects. U.S. stocks might have have trailed Hong Kong-traded Chinese shares recently, but historical context shows outperformance: the S&P 500 Index has hit records this year, while the MSCI China is down more than 6 percent from 20 years ago.

There are those who see this year’s mainland-made rally as a sign the best is yet to come.

“When a lot of global investors were and are still significantly underweight, it’s not a bad thing at the end of the day to see that new category of investors who are better believers in those assets,” said David Gaud, head of emerging equities at Edmond de Rothschild Asset Management in Hong Kong. The funds from the mainland are “much more structural and probably longer term than anything else we’ve seen in Hong Kong,” he said.

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