This article is part of Morningstar’s Guide to Investing in Asia where we navigate the potential risks, for the chance of fantastic rewards from across the continent.
Buying a share in a UK-listed company is easy. As long as you have sufficient cash you can buy in to any company listed on the London Stock Exchange. Buying stocks listed outside of the domestic market is more complicated, with unique sets of rules to each country and stock exchange.
In the past, international investors buying into China were highly restricted, but new policies have been put in place to encourage foreign investors – albeit on China’s terms. Similarly it has been historically difficult for Chinese investors to own anything other than China stocks but the restrictions are loosening.
Connecting Investors
Government initiatives, such as the Qualified Foreign Institutional Investor (QFII) quota system and the launch last year of the Shanghai-Hong Kong Stock Connect, which gives Hong Kong investors direct access to Shanghai-listed stocks, and China investors access to Hong Kong listed stocks, have opened up foreign investor access to China stocks. But it is still a tough market.
When it comes to the nitty gritty of stock selection; H shares, listed in Hong Kong, can be easily accessed by foreign investors, and ADRs or GDRs – Chinese companies which have incorporated outside of China are also easy to buy. But is the A share stocks, those listed in China which are the most elusive. These A shares are the most sensitive to China’s underlying growth story, and as they are priced in renminbi they allow savvy investors to take a currency punt too.
One method for institutions to invest directly in China is “mutual recognition”. This allows asset managers to sell in China what they can raise in Hong Kong, and vice versa. This unfairly restricts Hong Kong operated funds however, as there are seven million people in Hong Kong, and 1.2 billion in China.
“The Chinese investment market is highly regulated,” says Mark Talbot, Managing Director for Fidelity Asia Pacific. “Even your website design is controlled as an asset manager in the region. This is challenging, but it is changing. Recently the government approached Fidelity to discuss how the industry might be improved.”
QFII is less restrictive than mutual recognition. Introduced in 2010 and expanded three years later requires institutional investors to apply for a quota, the amount they are allowed to invest into the Chinese market. However, it is not without flaws; if you take out any money from China you are not allowed to reinvest it – you lose that part of your allowance. This means mass outflows – such as the ones over the summer when investors spooked following market volatility – become problematic.
It also makes this method impossible for tracker funds to utilise. They are constantly adjusting holdings to reflect the underlying index, and so would lose their quota allowance in no time at all.
RQFII, an evolution of the policy, is more flexible and better set up to manage flows. It allows license holders to bring money on and off shore daily, but it is only for open-end funds. Asset managers are also restricted in their RQFII quota – assets under management in China must not exceed what they have in Hong Kong.
Chinese Investors: Speculate, With Hopes to Accumulate
Compared to a country like the US where the individual is responsible for their own pension provision and people from all pay grades happily discuss their investment portfolios, the China retail investor market is very immature. But this will have to change, as more Chinese are employed by private firms rather than the State and their pensions are provided by a defined contribution saving scheme not that dissimilar from those we have in the UK. The aims of the Chinese government to hand over pension provision to the individual and the private sector directly juxtapose current attitudes towards share ownership.
The hurdles that have to be overcome for this transition to be a success are cultural; right now Chinese investors prefer to speculate rather than invest for the long term. And they are speculating solely with China-listed stocks, as for now this is all they can easily buy, resulting in highly volatile investment returns – hardly a profile to rely on for pension provision. This is improving however, with future polices expected to connect Chinese investors with stock exchanges further afield; into Europe or the US.
