HONG KONG -- A year in, the Shenzhen-Hong Kong Stock Connect program is bringing a steady flow of foreign capital to the mainland bourse as investors snap up yuan-denominated A-shares to be included in an international index and seek to capitalize on growing consumer spending. Contrary to the similar arrangement with Shanghai that kicked off two years in advance, global investors are drawn into Shenzhen where less overlaps with Hong Kong and more consumption-related small caps in the constituencies.
Heavy northbound traffic
The so-called "northbound," trading in Shenzhen via Hong Kong, from the program's launch on Dec. 5, 2016, through the end of November totaled 868.8 billion yuan ($131 billion), roughly double the 472 billion Hong Kong dollars ($60.4 billion) in turnover in the other direction, data from Hong Kong Exchanges & Clearing shows. The top 10 stocks by northbound turnover include surveillance camera manufacturer Hangzhou Hikvision Digital Technology and appliance maker Midea Group.
Net northbound stock purchases came to 146.4 billion yuan over the same period, topping the southbound figure of HK$111.5 billion by roughly 50%. This differs markedly from the Shanghai-Hong Kong link, where net buying is higher in Hong Kong than on the mainland side.
The two stock link programs connecting Hong Kong and the two mainland bourses -- Shanghai and Shenzhen -- were introduced to create new routes to buy and sell A-shares, as access to them are still limited. Besides the two links, the only official channel is a framework called qualified foreign institutional investors, or QFII, where Chinese authorities grant licenses and quotas at their will.
Even though the window has gradually become wider since May 2003, when UBS and Nomura had been granted $50 million each, the total investment quota is around 1.2 trillion yuan, just about 2% of the total market capitalization. This includes a similar arrangement called R-QFII, introduced in 2011, which utilizes yuan that are circulating outside mainland China.
Buying activity has picked up since MSCI said in June that it would add yuan-denominated A-shares to its emerging-markets index in June 2018. The Shenzhen-Hong Kong link seems to have become a key access route to A-shares for foreign investors eyeing index-linked investments, as well as for traders looking to get a step ahead of that trend.
But this temporary surge is not the only factor at work. Two characteristics unique to the Shenzhen market -- a relative lack of overlap with Hong Kong shares and a high proportion of stocks related to China's growing consumer spending -- have driven broad-based buying via the Hong Kong link.
With dual Hong Kong-mainland listings, foreign investors tend to prefer trading in Hong Kong, where institutional investors predominate and stocks typically are priced reasonably based on companies' actual value, rather than on a mainland where rumor and speculation often move markets.
Hong Kong shares 72 listings with the Shanghai Stock Exchange, among them such big names as Ping An Insurance Group and Bank of China (BOC). But overlap with the Shenzhen Stock Exchange is limited to just 17 companies, according to the Securities Times, a mainland daily newspaper issued by the Communist Party mouthpiece People's Daily.
Most Shenzhen-listed stocks are exclusive to the bourse, including Gree Electric Appliances, drugmaker Yunnan Baiyao Group and baijiu hard-liquor producer Wuliangye Yibin.
Growing purchasing power
The makeup of the Shenzhen exchange's roster has drawn interest as well. Such consumer-related names as baijiu maker Kweichow Moutai and appliance giant Qingdao Haier are among Shanghai's more popular stocks of late, but the market consists in large part of big state-owned enterprises in such fields as finance and resources. The Shenzhen market's role was redefined in the 2000s to make it a platform for small and midsize businesses, and it hosts many upstart technology and consumer-oriented companies.
Shanghai has just one consumer-related company -- Kweichow Moutai -- among its top 10 stocks by market capitalization. Shenzhen has five, including Hikvision.
At the once-in-five-years Communist Party Congress in October, General Secretary and President Xi Jinping set out a goal of substantially expanding the middle class by 2035. Foreign investors are taking note of rising spending among this demographic, said strategist Andy Wong of Hong Kong asset management firm Harris Fraser.
Mainland Chinese stock markets remain dominated by local retail investors and basically closed to outsiders. If initiatives like the Shanghai and Shenzhen stock links and A-shares' inclusion in international indexes diversify the landscape, mainland investors will likely be forced to take greater care to evaluate economic trends and companies' growth potential.
Investors will also be watching for action by Chinese authorities to make mainland markets more accessible, such as raising daily quotas on the stock links and curbing frequent trading halts.