A-Shares: All Quiet on the Eastern Front


Two years ago this month (June) China’s A-shares (shares that trade on the Shanghai and Shenzhen stock exchanges) reached their highest level since the global financial crisis, after rocketing almost 80 per cent in six months. The market then slumped more than 43 per cent over the subsequent 11 weeks.

Shares of companies that are based in mainland China, quoted in renminbi and listed in Shanghai or Shenzhen, are notoriously volatile. The A-share market is dominated by millions of retail investors so rumour and speculation exert undue influence over investment choices.

Add to this the state-sponsored manipulation that alternately support and impede this market, and you have the basis for the wild swings that have confounded attempts to use share prices as a gauge of corporate quality and economic health in China.

Fast forward to this year, and while there are plenty of things around the world to lose sleep over, the A-share market no longer seems to be one of them. In fact, the MSCI decided this month to add A-shares to its influential global emerging markets and ACWI indices.

Investors are experiencing a period of uncharacteristic stability. The last time the Shanghai Shenzhen CSI 300 Index moved more than 2 per cent in one day was on December 12 last year, when the gauge declined 2.42 per cent. The last time the index shifted more than 5 per cent in a single session was on February 25 last year, when it fell 6.14 per cent.

Some things haven’t changed. Stability is a result of, to a great extent, more stimulus ahead of the 20th anniversary of Hong Kong’s handover to China and a carefully stage-managed leadership re-shuffle in Beijing; corporate governance is very much a work- in-progress despite signs of improvement; excessive debt in the financial system, as well as shadow banking, are in the headlines once more.

However, we’re also seeing signs of more institutional money coming into this market, which is a good thing because professional investors have a clearer idea of why they bought something and are less likely to panic at the first sign of trouble.

Some of this money can be attributed to the so-called ‘national team’ – state-backed firms instructed by Beijing to support share prices. They accounted for nearly 5 per cent of the market free-float in the first quarter, from zero in the same period two years ago, according to data compiled by Wind and CICC Research.

However, non-retail investors accounted for nearly 22 per cent in the first quarter, up from 17.5 per cent in the corresponding three- month period in 2015, the data show. In addition to the national team, these include domestic mutual funds, insurers, social security funds; Qualified Foreign Institutional Investors; and investors accessing this market from Hong Kong via Stock Connect.

The two Stock Connect schemes – direct trading links connecting Shanghai and Shenzhen with Hong Kong – have made A-shares more accessible to institutional investors operating outside the mainland. While so-called ‘northbound’ investments haven’t been as big as flows going the other way, this is still new money being put to work.

That’s why the Hong Kong Securities Clearing Company (HKSCC) now holds the second-largest stake in Shanghai-listed Kweichow Moutai, a company which overtook Diageo as the world’s most valuable liquor-maker earlier this year. HKSCC holds shares on behalf of Stock Connect users.

This is important because the management is paying more attention to minority shareholders. Company executives now fly to Hong Kong to meet investors, whereas previously one had to travel to Guizhou province in Southwest China to see them. The firm also introduced an employee incentive plan and increased dividend pay outs following consultations with shareholders.

With rising foreign participation in China’s financial markets, the authorities are keen to introduce more professionalism into the domestic fund management industry. In turn they hope to influence Chinese companies through greater exposure to international best practices.

These are incremental developments that, nevertheless, give us reason for optimism. Meanwhile, China is also changing. New patterns of growth favour nimble private sector companies which operate in a highly competitive environment (unlike those in the state sector) and demonstrate more discipline.

Domestic consumption accounts for more than half of the economy and we believe the key to unlocking shareholder value is to identify those companies that can tap into growing disposable incomes, while operating largely free from government interference.

The A-share market offers the largest pool of Chinese companies, with some having the potential to become market leaders domestically, and even globally.

The A-share market offers the largest pool of Chinese companies, with some having the potential to become market leaders domestically, and even globally. This is a market that is being integrated into the global financial system and our confidence in Chinese companies is rising, albeit slowly.

We say slowly, because out of the more than 3,000 A-shares that are listed in Shanghai and Shenzhen, we see less than 100 that deserve serious consideration. Risks abound. These are still early days, but the bigger risk for investors may lie in ignoring this market altogether.


The article above was previously published on Aberdeen Asset Management’s ‘Thinking Aloud’ blog on 22nd June 2017