The ABCs of China’s Share Markets
A shares, B shares, H shares. Chinese equity listings can be confusing to global investors. I’m often asked what I think about a particular share market in China, why one is outperforming others, and which to invest in. I can’t tell you what to invest in, but I can give you some information which I hope will help you discern what choices make sense for you.
Listed companies in China fall under three primary categories: “A” shares, “B” shares and “H” shares.
A shares are those of local Chinese companies denominated in Renminbi, traded primarily between local investors on the Shanghai or Shenzhen stock exchanges. Qualified Foreign Institutional Investors (QFII) who have been granted special permission by the Chinese government can also participate in this market.
B shares represent Chinese companies with a face value in Renminbi, but listed for trading to primarily international investors in U.S. Dollars as in the Shanghai exchange, or Hong Kong Dollars as in the Shenzhen exchange. Mainland Chinese investors may also trade B shares with legal foreign currency accounts.
H shares represent Chinese companies regulated by Chinese law, but are freely tradeable by anyone. H shares are listed in Hong Kong and are quoted in Hong Kong Dollars—hence the “H.”
Some investors also refer to companies that may not be incorporated in China but have their primary business there as L shares (trading the London Stock Exchange) and N shares, which trade in the U.S. on the New York Stock Exchange, NASDAQ, or the American Stock Exchange.
The “red chips” represent companies incorporated in Hong Kong, but whose primary business interests are in mainland China.
Other investment choices include dim sum bonds (bonds denominated in Renminbi being issued in Hong Kong), RQFII (a new scheme where Chinese managers invest into mainland securities with Renminbi raised in Hong Kong), and RMB bond products, just to name a few.
There are several reasons for performance differences in these markets. Overseas listed Chinese companies have varied tremendously in their risk-adjusted returns. Corporate governance in some Chinese companies listed in the U.S. has been rather poor, while the Chinese H or red-chip shares listed in Hong Kong generally have better governance because of the more stringent regulatory framework. Since Hong Kong is a window to mainland China, the Chinese authorities generally list what they view as the “best” assets there. Usually these are the state-owned companies with dominant positions in key industries, such as telecommunications or transportation. We believe they are regarded by the Chinese regulator as better run.
In China’s A-share market, the IPO system has not been entirely objective, so what investors or analysts might consider the “best” companies have not necessarily been listed there. This is why we think it’s so important to conduct thorough research across a broad list of companies, and then to carefully screen them. In the A-share market in particular, investors also have to recognize the political risk in China; its capital market is not yet fully mature and its regulatory standards still lag leading markets like Hong Kong and Singapore.
We recognize that performance in the A-share market has been disappointing to many investors this year, for a few reasons. Chinese investors lost confidence in the market, and an excess of Chinese IPOs (including a rush of Chinese listings on U.S. exchanges, particularly in 2010-2011), has had a dampening effect on secondary trading. Restrictions on foreign investment have also created some liquidity imbalances. The government is now allowing more investors to come in, which we find encouraging, but the amounts are still small and reform will take time.
To make the A-share market more attractive to all types of investors, we think China’s regulators should ensure that rules are fair and reasonable to all parties. In our opinion, there should be sufficient regulatory oversight and enforcement to ensure companies meet listing standards, have high corporate governance standards and are fair to minority shareholders. Rules such as “mandatory dividends” that override management decisions can discourage quality companies from listing.
Opportunities and Risks in A Shares
Despite some dampening influences, many investors feel the A-share market looks more expensive than the H-share market. That may be true if you look at the general numbers for the market overall, but that can be misleading because large-cap companies dominate the H-share market. Our research shows the premium is not as big as many believe in the A-share market. In fact, we believe the valuations of many mid- to large-cap companies in the A shares, especially in the banking, insurance, building materials and automobile sectors, are currently trading at a discount or at least in line with many H-share companies.
In our team’s opinion, there are good buying opportunities in the A-share market right now. Valuations dipped quite a bit amid a significant market decline this summer, and we have been searching for bargains in companies we think are of good quality and trading at attractive valuations relative to their intrinsic value. Consumer goods and diversified oil companies, operating inside and outside China, are sectors of particular interest to us right now. Our team also likes the pharmaceutical and biotechnology sectors, but we feel current valuations are still a bit too high.
The A-share market also offers investors a number of appealing characteristics. It contains a much larger number of listed companies than the other markets. In addition, sector representation is more balanced and diverse. For example, investors can gain exposure to some smaller companies and sectors not available via red chips or H shares, such as tourism, Chinese pharmaceuticals (traditional medicine) or spirits.
As I’ve stated before, I believe China can maintain strong long-term economic growth (even if at lower levels than the double-digit growth rates of years past) and believe there are reasons to be optimistic as an investor in its various markets. China may be growing at a somewhat slower pace, but it is slowly becoming less dependent on exports, and it is investing for its future growth. Investors should be happy to see that happen.
China’s once-a-decade leadership changeover over the next few months is adding a bit of market uncertainty. However, we believe the structural changes and market reforms that are already underway there should continue to create a more balanced growth model, and that China and its people should continue to gain clout in the global economy.