A-Shares Mania

JUNE 11, 2015

Recently, index providers FTSE and MSCI decided to include Chinese A-shares in their Emerging Market indices. This of course has only heightened investors' enthusiasm for these stocks—which have more than doubled in the last year—since the billions of dollars in funds tracking various FTSE and MSCI indices will need to acquire A-shares themselves.

A-shares are Chinese companies listed domestically that until recently were mostly off-limits to foreign investors. Most ETFs like the iShares China Large-Cap (FXI) get exposure through H-shares, which are listed in Hong Kong but represent only a subset of Chinese equities. Now that A-shares are more widely available to foreign investors it makes sense to include them as a matter of indexing, but are investors in such index funds buying into assets that are already overheated?

Valuations suggest they are. For example, stocks in the Deutsche X-trackers Harvest CSI 300 China A-Shares fund (ASHR) are trading at 18x forecast EPS for 2015, a 60% premium to stocks in FXI, and about 50% higher than those in the broader iShares Emerging Markets fund (EEM, Figure 1).

Even more telling about the degree to which the A-share market is overheated may be the Hang Seng China AH Premium Index, which tracks the relative prices of 59 stocks that have both A- and H-share classes available. Theoretically there should be little difference since institutional investors can arbitrage between the two markets, but in reality practical constraints have A-shares now trading at a 40% premium versus their H-Share counterparts, the largest since mid-2009 (Figure 2).

This premium could grow even larger as index funds look to acquire temporarily scarce A-shares, but we don't think it will persist indefinitely. The truly brave might profit from a long FXI/short ASHR trade.

Figure 1: P/E Ratios on 2015E EPS
Source: AltaVista Resesarch
Figure 2: HS China AH Premium Index
A-Share ÷ H-Share prices, 2006-present
Source: Hang Seng Indexes