In November 2014, when China launched Hong Kong-Shanghai Stock Connect, a pipeline designed to facilitate two-way flows between two hitherto largely sealed off equity markets, identical stocks listed on both exchanges were, on average, 2.1 per cent more expensive in Shanghai.
After three years of operation, during which a net Rmb920bn ($142bn) has flowed through this conduit and a sister HK-Shenzhen channel opened a year ago, the typical premium that dual-listed stocks trade at on the mainland market has ballooned to 30 per cent, as the first chart shows.
“At the beginning of the [Stock Connect] process I think the expectation was that the [price] gap would be erased, but the [Shanghai and Shenzhen-listed] A-shares are trading at a 30 per cent premium relative to the [Hong Kong] H shares. That is well above the historic average of 15-20 per cent over the past seven to 10 years,” says Dmitriy Vlasov, a portfolio manager at East Capital, an emerging market-focused fund house.
“The A/H [shares] situation is indeed a strange one,” says Gary Greenberg, head of global emerging markets at Hermes, another asset manager.
Some of the price differentials between identical stocks, with identical voting rights and dividend streams, are extraordinary.
Shares in Tianjin Capital Environmental Protection, a water utility, are 3.5 times more expensive on the mainland than in Hong Kong. Shanghai Electric, CSSC Offshore & Marine Engineering, Cosco Shipping Development Company and Metallurgical Corp of China are all at least 2.5 times as expensive on the A-shares market.
In contrast, only one of the 70 dual-listed stocks in the Hang Seng China AH Premium index, Anhui Conch Cement, is cheaper on the mainland, by 7.3 per cent. When Stock Connect was born three years ago, 20 stocks cost less in Shanghai or Shenzhen than in Hong Kong.
Yet this widening gulf cannot be blamed on Stock Connect itself. After a quiet first year, far more money has gushed through the pipeline into Hong Kong than in the opposite direction.
But the Stock Connect can be blamed for failing to correct the anomaly.
“The stocks are non-fungible,” says Mr Greenberg. While the same shares are available on both exchanges, their trading environments are clearly not the same.
One factor would appear to be the bubble in mainland equity prices that began inflating in November 2014, just as Stock Connect was implemented, and which far outstripped a jump in Hong Kong prices that kicked in a few months later. This pushed up premiums for dual-listed shares in mainland China.
Both stock markets fell sharply later in 2015, but although the HK bourse has performed better since, these premiums have not fallen to any great extent.
Richard Gao, research principal at Matthews Asia, a San Francisco-based asset manager, notes that the premiums tend to be highest when there is a bull market in both mainland and Hong Kong equities. He attributes this to the momentum-driven investment style favoured by many Chinese retail investors.
Flows to Hong Kong from the mainland have clearly not been enough to outweigh this. But they have been rising, nevertheless.
Recent data from East Capital suggest cumulative net “southbound” flows, ie into HK, have reached Rmb578bn, comfortably outstripping net flows of Rmb341bn in the opposite direction, as seen in the second chart.
Mr Vlasov views the Stock Connect programme as a “clear success” that has “essentially integrated China’s onshore and offshore markets” and allowed mainland investors to diversify their financial holdings by, for instance buying into Chinese technology companies, car manufacturers and insurers that are not listed on the mainland.
While northbound flows via Stock Connect have only accounted for 1 per cent of turnover in mainland stock markets this year (with food and beverage and consumer companies in most demand), southbound flows have constituted 7 per cent of activity in Hong Kong.
Mr Vlasov says Hong Kong-listed bank stocks have proved very popular for southbound investors, and as a result the discounts in HK for the five dual-listed banks are all below the 30 per cent average.
The mystery is perhaps why even more money has not found its way from the mainland into Hong Kong, given the attractive discounts on offer.
It may simply be that investors in A shares feel that this is where the biggest gains are to be made.
Yet even those in search of discounts face some barriers. One such is that Stock Connect is only open to those with investable assets of at least Rmb500,000 ($77,000). This rules out many retail investors, who dominate trading in mainland markets.
As Mr Greenberg points out, retail investors receive negative real interest rates on their deposits “which can lead to silly [stock market] valuations if that is the hurdle rate”, given that the domestic bond market, another potential alternative is “under-developed”.
But smaller retail investors are not entirely held captive on the mainland. They can participate in Stock Connect through mutual funds, wealth management products and other pooled vehicles.