New connect widens investors' options

The Shenzhen-Hong Kong Stock Connect slated to launch sometime later this year will make China's equity market more accessible to global investors seeking exposure to China's fast-growing companies.

The stock connect to the bourse in the southern Chinese boomtown Shenzhen offers global investors an opportunity to diversify into China's tech and service companies, which has proved much more resilient to slowing growth in the world's second-largest economy.

"The Shenzhen exchange has a far more diverse mix of companies that reflects China's new consumer and tech-driven growth prospects," said Gao Ting, chief of China equities strategist at UBS Securities.

Most of the stocks listed on the Shenzhen Stock Exchange have a market capitalization of less than $2 billion, but have posted faster earnings growth than their large-cap peers listed in Shanghai.

Once the stock connect is launched, the investible market capitalization for global investors from information technology and consumer discretionary to healthcare will expand, adding opportunities for them to diversify Chinese equity holdings away from financial and manufacturing firms.

Earnings growth for Chinese mainland-listed companies in IT, healthcare and consumer discretionary stood at 35.1, 24.4 and 12.9 percent in the first three quarters of 2015, compared with 3.4 percent for manufacturing, and a decline of 64.1 percent and 55.5 percent for energy and materials respectively, according to data compiled by researchers at Wind.

Average earnings growth for listed companies on the Chinese mainland has moderated from 14.3 percent in 2013 to 3.2 percent in the first three quarters of 2015 along with China's slowing economic growth.

The Shanghai-Hong Kong Stock Connect launched in 2014 has already provided investors in Hong Kong with a daily quota of 13 billion yuan ($2 billion) to invest in shares listed in Shanghai.

Other than that, overseas institutional investors can invest in China's onshore capital markets through the qualified foreign institutional investors program and a similar scheme using Chinese yuan raised offshore, called RQFII.

The free float market capitalizaiton at the Shenzhen bourse is smaller than that in Shanghai but trading has been much more active as domestic investors prefer small-cap stocks.

But such preference has also buoyed share prices. Companies in Shenzhen currently trade at about 39 times their estimated earnings, compared with 15 times for those traded in Shanghai.

Analysts say such high valuation could keep global investors on the sidelines when the Shenzhen-Hong Kong stock connect is launched.

"They will compare stocks in Shenzhen with those in other markets across the region and think some of them are just too expensive," Gao said.

He added that global investors are still looking for growth stories in the Shenzhen market, but only stocks with a reasonable price-to-earnings ratio.

"The stock connect is a good opportunity for offshore investors to diversify into China's consumer and IT sectors but capital inflow from Hong Kong could remain subdued at first as investors balk at stocks' high valuations," he said.