COMMENTARY: Foreign Investors Keep Snagging Chinese Mainland Stocks

More than a quarter trillion dollars’ worth of Shanghai, Shenzhen equities now held internationally despite political headwinds.

Mark Melnicoe
    Nov 16, 2019 5:05 AM  PT
COMMENTARY: Foreign Investors Keep Snagging Chinese Mainland Stocks
resource from: (Image: Mark Melnicoe)   
(Image: Mark Melnicoe)

Despite the trade war and volatility in China's stock market, foreign investors continue to increase their stakes in the country's equities. At the end of the third quarter, foreign holdings in Chinese stocks surpassed $253 billion – the fourth straight monthly rise and an increase of almost 40% in a year, the People's Bank of China reported.

Reasons include the loosening of regulations on foreign buyers and ease of foreign purchases via the Stock Connect linking Hong Kong's exchange to those in Shanghai and Shenzhen. But China's economic story, which investors clearly think has not run its course, must be considered the prime motivator.

Bucking the Trump administration's best efforts to thwart its technological rise, China is succeeding in helping companies become more innovative across multiple industries. They include pharmaceuticals, artificial intelligence, telecommunications, e-commerce, robotics and advanced transportation, to name a few. Some, such as Alibaba Group Holding (NYSE: BABA), Tencent Holdings (OTC: TCEHY; HKEX: 0700), Ping An Insurance (HKEX: 2318) and privately held Huawei Technologies, are becoming world-class companies. More will follow.

Raising the Inclusion Factor

The latest indication of China's further integration into the global equities markets came when MSCI announced this week it will carry through with its planned boost in the presence of Chinese A-shares in its emerging markets index fund. MSCI announced that its weighting of 268 large-cap mainland stocks in the widely used benchmark index will increase and that about 175 mid-cap stocks will be included for the first time.

Effective November 26, the move will take the overall weight of A-shares (those traded on the Shanghai and Shenzhen exchanges) to 4.1%, up from 2.55%. It will mark the third increase in the weight of China's A-shares in the MSCI index this year. Other international index fund companies are also stepping up with more China holdings.

Against this backdrop, the trade war continues. A bipartisan group of lawmakers introduced legislation in Washington this month to bar the federal government's main employee retirement fund from investing in Chinese stocks. Led by Florida Sen. Marco Rubio, they said that allowing these investments amounts to "effectively funding the Chinese government and Communist Party's efforts to undermine U.S. economic and national security."

American lawmakers can pass whatever laws they want, and President Trump no doubt will sign this one if it passes. But they are swimming against a strong and historic tide. With China rising from economic backwater 40 years ago to the world's No. 2 economy in barely over a generation, its stocks have long been underweighted in global indexes. Investors around the world want a bigger piece of that pie.

Holdings of Chinese stocks in the index funds of MSCI, Standard & Poors, FTSE Russell and others dwarf what would ever be contemplated by the Federal Retirement Thrift Investment Board, which oversees the federal retirement plan. These index funds no doubt will continue to increase both stock and bond holdings from China.

Shift to Open Markets

In another boost for companies, the China Securities Regulatory Commission recently announced a plan to relax controls over publicly listed firms' follow-on offerings, the Caixin news portal reported. The move came more than two years after the CSRC largely curbed such activities. And while investors have been seeking the removal of secondary share sale curbs, Caixin reported that some analysts were pleasantly surprised at how market-friendly the proposed loosening is.

So, while things are looking up in the mainland, there was more evidence that things aren't going so well for Chinese companies listing overseas. In IPOs on Nasdaq, two companies raised much less money than they had anticipated – a signal that investors may be souring on fast-growing Chinese companies that aren't earning profits.

Many investors have been burned by such companies, and the luster of big Chinese IPOs seems to be wearing thin. 36Kr Holdings (Nasdaq: KRKR), a news and data provider based in Beijing, raised just $20 million in its IPO on November 8. It closed the day down 10 percent after it slashed its initial offering from 3.6 million to 1.4 million shares at the low end of its price range.

The same day, Shanghai-based Ecmoho Ltd. (Nasdaq: MOHO), a health and wellness products retailer, raised just $44 million, far short of its goal to raise $150 million.

Although it was only five years ago, it feels like another era when Alibaba raised $25 billion on the New York Stock Exchange in the largest IPO in history. Those days seem long gone for Chinese companies – at least on this side of the Pacific. In China's financial center of Shanghai, things may be just getting started.