Exploit China’s shares gap

If you’re planning to invest in China, it’s useful to understand that there are two very different types of shares that fall under the broad term “Chinese shares”.

“A shares” are shares of companies that are based in mainland China and listed on the Shanghai or Shenzhen stock exchanges. These shares are quoted in renminbi and historically were only available to be traded by mainland Chinese citizens and a limited number of foreign institutional investors. However, since the end of 2014, other foreigners have been able to invest in certain Shanghai-listed stocks.

“H shares” and “Red Chips” are shares of Chinese-based companies listed on the Hong Kong Exchange. They are quoted in Hong Kong dollars and are available for all foreign investors to trade in. Technically, H shares are companies incorporated in China and listed in Hong Kong, whereas Red Chips are mainland Chinese firms incorporated in Hong Kong – but this distinction will rarely matter to most investors.

The only time it’s likely to be important is when the same firm is listed in both Hong Kong (through H shares) and the mainland (through A shares) at the same time. These stocks will have identical rights and so should trade at the same price, but A shares often trade at a premium to H shares. The average premium has been around 20% over the past ten years, but has been highly volatile, reaching more than 100% in 2008.

The persistence of this premium is explained by China’s capital controls, which limit residents’ ability to buy H shares and foreigners’ ability to buy A shares, and by the fact that A shares and H shares can’t simply be swapped for one another. This reduces the opportunities for investors to exploit difference in prices (buying the cheaper H share and selling the expensive A share), which would normally be expected to arbitrage away the difference over time.

However, there is one way to take advantage of this inefficiency. The db x-trackers Harvest FTSE China A-H 50 Index ETF (LSE: AH50) invests in the 50 largest firms in the A share market – but for those firms that also have H shares it will buy the H shares if they are cheaper. The ETF only launched in March, so has yet to build up a record, but this unusual approach suggests it’s worth keeping an eye on how it well it works.

Fees predict survival

Lower-cost funds tend to perform better than expensive peers, according to a new study by Russel Kinnel of Morningstar. His research, released at the beginning of May, found that ongoing expenses for US mutual funds and exchange-traded funds (ETFs) were a simple but powerful predictor of whether the fund would outperform over the next five years.

The cheapest funds were “at least two to three times more likely to succeed than the priciest funds”, says Kinnel. “Strikingly, our findings held across virtually every asset class and time period we examined.” The least-expensive category of funds had a success rate of 62%, which decreased to 48% for the second cheapest, 29% for the middle category, 30% for the second priciest, and 20% for the most expensive.

Importantly, the study included funds that no longer exist as well as those that are still open. Because expensive funds are more likely to underperform and underperforming funds are more likely to be closed, leaving out funds that no longer exist will make the performance from higher-cost funds appear better than it actually is. This problem, known as survivorship bias, is a common one when assessing the past performance of funds.


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