8 th Annual Masters of Investment Management China A Shares vs. H Shares: Tracking the Changes in the A-H A H Price Difference Vincent Kwan Managing Director 28 September 2007 Version 2.0
Agenda 1. Why A / H shares trade at different prices? 2. Should they trade at the same price for the same company? 3. Any methods to measure the price differential? 4. Does any profit opportunity exist for investors? 1
Why A/H shares trade at different prices? 2
Will you Be Surprised? Shop A Shop B Shop C Coke $5.50 $4.50 $3.00 Plasma TV $21,500 $18,500 $17,500 Why do we accept Identical product selling at different prices at different location? 3
How About Across Different Countries? The retail price of a Big Mac (Jan 2007) Country Big Mac Prices In Local Currency In Dollars Country Big Mac Prices In Local Currency In Dollars United States $3.22 3.22 Hong Kong HK$12.0 1.54 Canada C$3.63 3.08 China Yuan11.0 1.41 Britain 1.99 3.90 Argentina Peso8.25 2.65 Denmark DKr27.75 4.84 Saudi Arabia Riyal9.00 2.40 Japan 280 2.31 Australia A$3.45 2.67 Source: McDonald s; The Economist They are very different 4
The A/H Price Anomaly (As at 25 Sep 2007) A shares (CNY) H shares (HKD) A-share Premium Datang Power 大唐發電 20.96 8.25 162.73% Tianjin Capital 天津創業環保 10.28 4.29 147.81% Air China 中國國航 24.92 10.46 146.37% Huadian Power 華電國際電力 10.92 4.65 142.85% Jiangxi Copper 江西銅業 53.17 22.80 141.16% CHALCO 中國鋁業 47.92 21.40 131.57% and many others CNY 100 = HKD 103.41 What s the difference between A/H Shares and Big Mac? 5
EUR Possible Reasons for the A / H Price Differential Hong Kong Mainland China USD NOT convertible HKD JPY CNY Limited Convertibility 6 QDII Individual PRC citizens QFII Company H shares A shares Local Investors Domestic Investors Int l Investors
Can We Accept This As Normal For Now Hong Kong SAR Nationalisation Internationalisation Mainland China ONE COUNTRY TWO MARKETS TWO CURRENCIES TWO PRICES TWO SYSTEMS 7
Two Currencies, Two Prices A / H Price Ratio (%) 1,000 750 Tsingtao Brew CNYHKD Since Jan 1994 to Aug 2007 Better overall performance in A-share market CNYHKD 1.05 1.00 500 0.95 250 CNY appreciation 0.90 0 Launch of QFII in 2003 1994 1996 1998 2000 2002 2004 2006 0.85 Launch of QDII in 2007 8
Two Markets Top 10 AH Companies by Market Cap (As at 12 Sep 2007) A-share MV (USD Mn) H-share MV (USD Mn) Company Full FAF Freefloat Full FAF Freefloat ICBC 工商銀行 213,206 4% 8,528 53,867 45% 24,240 China Life 中國人壽 145,983 5% 7,299 35,407 100% 35,407 Bank of China 中國銀行 139,719 3% 4,192 37,490 40% 14,996 Sinopec Corp 中國石油化工 149,854 6% 8,991 17,844 100% 17,844 Ping An 中國平安 63,788 20% 12,758 26,518 55% 14,585 Bankcomm 交通銀行 47,160 7% 3,301 26,393 65% 17,155 CHALCO 中國鋁業 58,400 15% 8,760 10,333 100% 10,333 CM Bank 招商銀行 55,393 40% 22,157 9,778 100% 9,778 CITIC Bank 中信銀行 39,656 5% 1,983 9,206 40% 3,682 China COSCO 中國遠洋 32,614 15% 4,892 7,109 90% 6,398 Total 945,773-82,861 233,945-154,419 9
Same Company = Same Price Can Be Achieved An arbitrage mechanism should offset the different pricing of shares listing in different locations of the same company Example: HSBC Shares traded in HK and London are closely tracked Indexed Return (%) 150 125 London Hong Kong Indexed Return (%) 150 125 100 100 75 75 50 2000 2001 2002 2003 2004 2005 2006 2007 50 10
Should A shares and H shares trade at same price for the same company? 11
The Lessons from Big Mac What s the use of the Big Mac Index No one believe a Big Mac should cost the same in different countries Demand, Supply, Level of Competition, Taxes, Duties, etc.. might explain the price differences But being used as a way to predict exchange rate movements Market exchange rates usually differ from what being predicted by the Big Mac Index 12
Conditions for Same Product, Same Price Free Trade in EC0101 Goods are tradable (transportable) Lack of Trade Restriction No import duties, tariff No import quota No transaction costs The world is never that perfect 13
The Arguments for AH Shares Shares are different: Same underlying assets Same company prospects Same rights Same entitlements Investment, not consumables More importantly, Shares (Financial Assets) are: Easily transferable Low transaction costs Free of impedance 14
Can QFII / QDII / HSAHP Help to Narrow the Gap? QFII (Qualified Foreign Institutional Investors): Introduced in Nov 2002 as a provision for foreign capital to access China financial markets Quota Granted: ~ USD 10 Bn Slowing QDII (Qualified Domestic Institutional Investors): Launched in Jun 2007 that allows domestic institutional investors to invest in overseas capital markets Quota Granted: ~ USD 25 Bn Expanding fast Shortcomings: Only for Qualified Investors and Limited Supply 15
Questions Who know the companies better? A-share or H-share price better reflects the value? Should A-share price to fall? or Should H-share price to surge? 16
Any method to measure the price differential? 17
Any method to measure the price differential? 1. Any objective measurement of overall price differential? 2. How to measure the performance of these companies across both markets? 3. Any interaction between A-share price and H-share price? 18
Hang Seng China AH Index Series Hang Seng China AH Index Series 恒生 AH 指數系列 Hang Seng China AH Premium Index 恒生 AH 股溢價指數 Hang Seng China AH (A+H) Index 恒生 AH 股 A+H 指數 USD Hang Seng China AH (A) Index 恒生 AH 股 A 指數 Hang Seng China AH (H) Index 恒生 AH 股 H 指數 CNY HKD Same constituents for these 4 indexes 19
Hang Seng China AH Premium Index ( HSAHP ) Objectives To provide market with a simple and easy-to-use barometer to gauge such a premium (or discount) Measurement To measure the average price premium or discount of A shares over H shares, weighted by freefloat market cap 20
Calculation Methodology Formula Valuation of constituents based on A-share price Index = x 100 Valuation of constituents based on H-share price Freefloat number of shares (A+H) x A-share price = x 100 Freefloat number of shares (A+H) x H-share price Premium Index A shares at a discount A shares at a premium Lower than 100 100 Higher than 100 21
Index Performance 200 180 160 Hang Seng China AH Premium Index (3 Jan 2006 to 25 Sep 2007) High: 183.76 (17 Aug 07) Low : 85.01 (13 Apr 06) 200 180 160 140 140 120 120 100 100 80 Jan May Sep Jan May Sep 2006 2007 80 Daily Change Average 2.06 Max 10.46 Min 0.00 22
Long-term Direction for the A/H Price Differential? 200 Hang Seng China AH Premium Index (2 May 2007 to 25 Sep 2007) 200 180 160 140 H-shares followed global market down on US sub-prime crisis Announcement of resident s direct investment scheme 180 160 140 120 May-07 Jun-07 Jul-07 Aug-07 Sep-07 120 23
What are the Values of AH Premium Index? For benchmarking and market reference For forecasting the potential price movement of the A shares and H shares Particularly useful to track the A / H price differential phenomenon when China opens up its market through the QFII / QDII / Tianjin Pilot Project For derivative product development Hedging Arbitrage Difficulty: the A-share market is not completely open for foreign investment 24
Hang Seng China AH Price Indexes Hang Seng China AH (A+H) Index 恒生 AH 股 A+H 指数 USD Hang Seng China AH (A) Index 恒生 AH 股 A 指数 Hang Seng China AH (H) Index 恒生 AH 股 H 指数 CNY HKD Same constituents, same weightings Show purely price effect 25
Pro-forma Index Performance 4,500 3,500 AH (A+H) (USD) AH (A) (CNY) AH (H) (HKD) Backdate Performance of the AH Price Indexes (3 Jan 2006 to 25 Sep 2007) 4,500 3,500 2,500 2,500 1,500 1,500 500 Jan Apr Jul Oct Jan Apr Jul 2006 2007 Closing Index 1 month 6 months % Change over 12 months Since 3 Jan 06 500 (As at 25 Sep 2007) Annualized Volatility 1 (%) AH (A+H) 3,125.79 +16.7 +80.5 +166.2 +212.6 24.76 USD AH (A) 4,109.81 +11.6 +92.2 +225.5 +311.0 33.19 CNY AH (H) 2,691.00 +19.1 +71.0 +135.5 +169.1 27.30 HKD 1 Over the latest one year 26
Any profit opportunity exists for investors? 27
Any Profit Opportunity? 20 Aug 2007: Announced the launch of Tianjin Pilot Program that allows Mainland Chinese citizens to invest in Hong Kong equities Hang Seng Index 5.9% H-shares Index 8.7% Investors have shown great interest in purchasing H shares trading at deep discount relative to A shares after the news USD CHALCO 中國鋁業 Times USD Datang Power 大唐發電 Times 3.00 2.50 3.4x +100% 3.500 3.125 1.30 1.10 5x H-share Price (LHS) A/H Price Ratio (RHS) 5.200 4.525 2.00 2.750 0.90 +74% 3.850 2.3x 1.50 1.00 H-share Price (LHS) A/H Price Ratio (RHS) 2.375 2.000 0.70 0.50 2.6x 3.175 2.500 17 21 23 27 29 31 4 6 10 12 14 18 20 24 17 21 23 27 29 31 4 6 10 12 14 18 20 24 August 2007 September 2007 August 2007 September 2007 A-share Price +37% A-share Price -9% 28
A/H Price Differentials Narrowing, But Not Disappearing Sentiment, Liquidity A shares Price H shares Price 29 H Share Company Return Red-chip Return Index Futures? Insurance Company Invest Companies QDII Individual Investors Global Market
Profit Opportunity If the A / H price differential is to diminish and return to the par level, an investor might be able to make profit at a return rate: A / H Price Ratio (%) 180 160 Current A-share Premium at about 60% A / H Price Ratio (%) 1 Year 3 Year 5 Year 180 160 140 140 120 100 Annualised Rtn: 60.00% Annualised Rtn: 16.96% Annualised Rtn: 9.86% 2007 2008 2009 2010 2011 2012 120 100 30
Is There a Way to Play the AH Market? Premises: Now A-share Price 160 H-share Price 100 3-Year A-share Price = H-share Price (90% chance) Question: Method1: Method 2: How to make the 60 dollar profit? Short A shares, Long H shares Short the instrument that can track the AH Premium Index Or Long the instrument that is inversely correlated with the AH Premium Index 31
Where is the Market? Who wants to Short the AH Premium Index? Those who believe the A share premium will disappear over time Who wants to Long the AH Premium Index? Those who want to long A shares but being restricted by QFII Long H shares + Long AH Premium Index = Long A shares 32
Making H-Share More Available to Mainland QDII Direct Investment in Hong Kong market QDII Funds in China Selling to them at spot Index Fund in Mainland? ETFs in Mainland? 33
HSI Services Limited http://www.hsi.com.hk 34