“Overall we like China in 2017. We actually prefer (China listed) A-shares over H-shares (Hong Kong-listed) at the moment,” Taylor said in a briefing on Tuesday.
The call is a reverse from six months ago, when there was, on average, a 45% discount for buying H-shares compared to onshore stocks, he said. But now some large-cap stocks listed in Hong Kong such as banks and insurers, favored by foreign institutional investors, are even trading at premium to A-shares.
“That is not driven by instuitional investors abroad, but purely by southbound investments.” For instance, he noted, the Hong Kong-listed Chinese banks have held up quite well, “part of it was probably helped by the value trades,” in which the mainland institutions bought the discounted H-shares through the Shanghai-Hong Kong Stock Connect.
The Hang Seng China AH Premium Index, a measure of the price difference between A- and H-shares, now stands at around 123, a gradual drop from the level over 140 before May, according to data from the index compiler Hang Seng Indexes Company.
“We are seeing a real change in the markets globally. People are coming out of the consumer stocks – stocks that have been growing quite fast and became expensive – and moving into the value trades.”
In the US there is rotation from e-commerce stocks to mining stocks and Taylor believes the same will also happen in China.
“We have seen some oil companies change the management and cut capital expenses,” as well as some steel makers trying to cut capacity, he said. “[These factors] are not priced in, so we see some bottom-up restructuring ideas that have a lot of potential.” But he stressed that the picks are selective and he is not suggesting buying the whole sector.
A weakening RMB might not be a big concern anymore, he stated. The currency has depreciated 6.6% against the greenback, or roughly 5% against a basket of currencies since the beginning this year.
“The world now accepts that the RMB will be weaker, but China can still have reasonably good growth. There is a change in perception of the RMB in that the risk premium has turned lower.”
Other potential risks are the property market bubble bursting and the build up of bad debts, which are disguised by China’s banks. But he sees those as long-term issues rather than immediate cconcerns.
“We think the property market will be controlled [by the government]. The prices have picked up a lot, but it is an asset in recovery, not [linked to] an economic recovery, as there is no real increase in housing production. It does not have the same economic impact or multiplying effect like it did in 2005 and 2010.”
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The Hong Kong benchmark Hang Seng Index outperformed the H-shares focused Hang Seng China Enterprise Index and MSCI China index over a three-year horizon. Taylor believes the trend will not remain the same in 2017 as capital starts to flow into A-shares.
The chart below shows the three-year performance of Deutsche Invest I Chinese Equities Fund LC USD versus its benchmark MSCI China 10/40, both in US dollars:
