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There are many Chinese share classes, and we consider three to be key for international investors: A shares, H shares and American Depositary Receipts (ADRs). We are focusing here on A shares — renminbi-denominated shares listed on the Shanghai and Shenzhen Stock Exchanges. With almost 4,000 listings, A shares constitute the second-largest equity market in the world.

SHARE CLASS

DEFINITION

WHERE THEY’RE LISTED

TRADING CURRENCY

AVAILABILITY TO FOREIGN INVESTORS

A share

Local Chinese companies traded mainly by local investors in RMB on Chinese stock exchanges

China

RMB

Yes (Through QFII / RQFII / Stock Connect)

H share

Chinese companies regulated by Chinese law, freely tradable by anyone

Hong Kong

HKD

Yes

American Depositary Receipt (ADR)

Chinese company stocks held by US financial institutions, offered in the US

United States

USD

Yes (Through US brokerage account)

Source: FTSE, Hong Kong Stock Exchange, Invesco, July 2019

Why consider?

China’s A-share market may be the world’s second largest, but it’s still small relative to the size of China’s economy. Judging from China’s current pace of financial-market reforms, our belief is that the A-share market is set to grow rapidly. Here we outline the trends that make the asset class attractive.

 A better proxy for China's economy
Source: World Bank, latest data available, accessed on Oct. 14, 2019.

A proxy for China's economy

Good news to A-share investors wanting to invest in China's growth: changes to indices and plans for capital-market reforms should strengthen the correlation between A shares' performance and China’s economic development. This means that a better mix of companies, including those in old-economy (e.g. chemicals, industrials) and new-economy (e.g. technology-based, service) sectors, will be more accessible to foreign investors.

Increasing institutional participation may temper volatility

The A-share market is known to be volatile and this is often attributed to the dominance of retail investors. Things are changing, with participation from institutional investors increasing in recent years—a trend that's boosted by the MSCI inclusion. This way, the market should become less susceptible to the sentiment of retail investors.

Improving valuations

We expect China to focus on improving quality of growth while gradually trimming excess capacity and bringing down leverage. As a result, we may see Chinese companies’ profit margins and valuations gradually improve.

Strong alpha opportunities

Idiosyncrasies in the market point to a deep pool of alpha to explore. We believe that common fundamental investing styles that focus on company fundamentals and target biases in investor behaviors could work well in China over the long term. Evidence of this is that actively managed median mutual funds have outperformed their benchmark by over 6.6% over the past five years.

Figure-2
Source: Morningstar. Data based on open-ended EAA equity funds with no market-cap or style bias, net of fee, excess return is against relevant MSCI index. Data taken from July 1,2014 to June 30, 2019. Accessed on July 26, 2019. Past performance is not a guarantee of future results.
 Figure-3
Source: Bloomberg, FactSet, data as of June 30, 2019

Key takeaway

We believe the consumer goods and services, Internet, and healthcare sectors should lead earnings growth, as they'll benefit from structural growth drivers in consumption and services.

Ways to access

Access for foreign investors to China A shares has been improving following significant regulatory changes. In fact, China recently promised to lift restrictions entirely for the Qualified Foreign Institutional Investors (QFII) and Renminbi Qualified Foreign Institutional Investors (RQFII) schemes. It’s still unclear when the changes would take effect.

We summarize current access options here.

 

QFII / RQFII

STOCK CONNECT (NORTHBOUND)

Description

Allows licensed international investors to trade in the stock exchanges in Shanghai and Shenzhen. Linking the Shanghai, Shenzhen and Hong Kong Stock Exchanges to allow investors to trade shares in each market, using own brokers.

Advantages

■ Licensed institutional investors can trade A shares.

■ No limits on capital repatriation.

■ Investors can hedge to manage foreign exchange risks.

Gives foreigners an opportunity to buy selected A shares.

Disadvantages

■ Strict criteria for applications.

■ Complex process. Costs and regulatory requirements need constant attention.

■ Different tax rules across Chinese cities. Often applied on a case-by-case basis.

Daily investment limitations apply.

Who qualifies?

Fund managers, insurance companies, pension funds, charities with an operating history of at least 2 years and AUM of at least US$500m.

Participants must meet Hong Kong Stock Exchange’s requirements.

Any investment quota?

QFII: Raised to US$300bn in January 2019.

RQFII: RMB 693.3bn approved at end-August 2019.

China said on Sept. 10, 2019 that these quotas will be scrapped. No timeline presented. 

RMB 52bn for each of Shanghai and Shenzhen Connect as of Sept. 2019.

Limit on shareholding?

 

■ An investor’s shareholding not to exceed 10% of total shares.

■ Foreign investors’ shareholdings can’t exceed 30% of total shares.

■ No limit on strategic investors’ shareholding ratio.

 

■ An investor’s shareholding not to exceed 10% of total shares.

■ Foreign investors’ shareholdings can’t exceed 30% of total shares.

■ No limit on strategic investors’ shareholding ratio.

Eligible investment products

Common stocks, preferred stocks, bonds, funds, index futures, asset-backed securities, new share issuances, bond issuances, private placements and share allotments.

Selected A-listed and H-listed stocks that are:

■ Constituents of the SSE 180 and SSE 380 indices.

■ Constituent stock of the SZSE Component Index and SZSE Small/Mid-Cap Innovation Index with a market capitalization of at least RMB 6bn.

■ A listed stock that is not included in the above indices but is dual listed in H-share market.

Source: Hong Kong Stock Exchange, Invesco, information as of Jan. 17, 2019.
Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

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