Hong Kong small-caps: ready for China fever?

Mon Sep 26, 2016 9:38pm EDT
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By Samuel Shen and John Ruwitch

SHANGHAI (Reuters) - Chasing higher returns in a slowing economy, Chinese investors could soon dominate Hong Kong's stock market, likely redefining how shares, especially small-caps, are traded and priced there.

Chinese money will account for a third of Hong Kong's stock trading turnover in three years, up from a tenth now, UBS and other brokers predict. Some traders say it could hit 50 percent within five years.

That would be a sea change for Hong Kong's century-old stock market and a serious challenge to western players. European and U.S. investors now account for almost a quarter of stock turnover.

Fund managers say the inflow of Chinese money will be driven by deregulation, fears of yuan depreciation, and yield chasing as there are still wide valuation gaps between the two markets.

The shift could trigger a culture clash between fundamentals-dependent western investors and momentum-driven Chinese, who tend to be more aggressive and speculative.

It is likely to be most evident in Hong Kong's small-caps, as the opening of the Shenzhen-Hong Kong stock trading link, as early as November, will allow mainland Chinese to buy Hong Kong small- and mid-caps, bringing much-needed liquidity, but also likely speculative fever to growth stocks.

"Small-caps in Hong Kong have long suffered from poor liquidity ... and low valuations. Mainland investors have a penchant for growth stocks, often giving them stretched valuations," said Lu Wenjie, strategist at UBS.

"Mainlanders also like stir-frying concept stocks. A growth story with a 5-year horizon is often priced in just a week in China. Such an investment style will have a big impact on Hong Kong stocks."   Continued...

A floor trader walks during afternoon trading at the Hong Kong Stock Exchange in Hong Kong, China September 26, 2016. REUTERS/Bobby Yip