Recently we’ve been monitoring the correlation between the daily performance of the Hang Seng Stock Connect China AH Premium (HSAHP) Index and the Hang Seng Index. We’ve noticed that on days when the Hang Seng Index performs relatively poorly H-shares underperform A-shares and vice versa. This makes sense given overseas investors focus primarily on H-shares whereas domestic investors focus primarily on A-shares. However, we’ve been surprised by the strength of the negative daily correlation between the two indices: -82% since the start of this year.
This presents an opportunity for generating alpha: net buying H-shares when the Hang Seng Index underperforms and net selling H-shares when the Hang Seng Index outperforms. We are currently exploring this opportunity in more detail.
A-shares outperformed H-shares in July. The HSAHP Index rose by 4.7% over the month. This brought the index near its peak levels since the introduction of the Stock Connect program in November 2014.
Chart 1: China AH Premium Index Source: OQFM, Bloomberg
This index conceals some interesting divergences in A-H share prices.
The company with the lowest H-share discount is BYD. As the date of writing (August 4), its H-share (1211 HK) is trading at an 8.1% to its A-share (002594 CH). This is interesting given:
Berkshire Hathaway has been aggressively selling its H-share holding in BYD over recent months (https://asia.nikkei.com/Business/Automobiles/Buffett-s-Berkshire-Hathaway-drops-BYD-stake-to-less-than-5), and
Other H-share auto stocks trade at a far higher discount; for example, Guangzhou Automobile Group’s H-share (2238 HK) currently trades at a 69% discount to its A-share (601238 CH), and Great Wall Motor’s H-share (2333 HK) currently trades at a 59% discount to its A-share (601633 CH).
Notwithstanding the interesting share price divergences among Chinese automobile stocks, we believe that China Life Insurance currently presents the most attractive mispricing opportunity. Its H-share (2628 HK) currently trades at a 70% discount to its A-share (601628 CH). Such a discrepancy might be justifiable if it were a small company with an illiquid H-share listing. However, that is not the case. China Life Insurance is the largest life insurance company in China by gross written premiums, and the median daily turnover of its H-share is around US$42 million.
One of the things we monitor is how many standard deviations the current A-share premium is relative to the historic average over different time frames. The current A-share premium is more than 2.2 standard deviations above the 3-month average.
We consider this to be a significant mispricing opportunity that is likely to correct itself eventually. However, pinpointing a catalyst is challenging. China Life Insurance's H-share could keep underperforming for a prolonged period.
In the following section, we explore how these sorts of mispricing anomalies in Asia can endure for extended periods.
Unwinding of Mispricing Anomalies
In the long term, fundamentals rather than liquidity flows drive returns. The problem is the long term can seemingly be endless, especially when you’re a portfolio manager who has to justify monthly performance to investors on regular update calls.
We deal with this by spreading our bets across numerous stocks. High breadth effectively lowers our hurdle for success. So long as we get it more “right” than “wrong”, we can generate attractive risk adjusted returns.
It also means that we can ride losing positions for longer as we’re not reliant on a small number of big bets paying off. As we've discussed previously, we don't like stop losses (https://www.oqfundsmanagement.com/post/are-stop-losses-an-appropriate-risk-control-mechanism).
In our July newsletter we wrote:
“… across Asian equity markets, liquidity flows rather than fundamentals are driving extreme share price divergencies. In Australia, NEXTDC and Goodman Group (whose growth outlook is contingent on data centre demand) are far more expensive than stocks listed in Singapore with significant data centre exposure (KDCREIT and Mapletree Industrial Trust). The contrast with Singapore Telecom is even more stark given its increasing data centre exposure and extremely cheap SOTP valuation. We believe this is because Australian investors tend to focus solely on Australian equities whereas Singaporean investors are more likely to have a regional focus, exposing them to more AI investment opportunities, particularly in Taiwan and Japan.”
We have short positions in NEXTDC and Goodman Group, and long positions in KDCREIT, Mapletree Industrial Trust and Singapore Telecom. This positioning materially detracted from the fund’s performance over the first half of this year. The good news is stock fundamentals finally played a dominant role in determining prices for these stocks in July. The July returns for each stock are shown below.
Table 1: July Returns for Selected Stocks Source: OQFM, Bloomberg
Stock Name | July Return |
NEXTDC (NXT AU) | -5.0% |
Goodman Group (GMG AU) | 1.0% |
KDCREIT (KDCREIT SP) | 12.2% |
Mapletree Industrial Trust (MINT SP) | 9.5% |
Singapore Telecom (ST SP) | 16.0% |
It was particularly pleasing to see Singapore Telecom perform strongly. The following extract is from our April newsletter:
“We believe the most attractive opportunity currently is Singapore Telecom (ST SP). It has a 29% holding in Bharti Airtel (BHARTI IN) which at month-end represented over 75% of Singapore Telecom’s enterprise value. Incredibly, Bharti Airtel has returned almost 70% over the last 12 months while Singapore Telecom has generated a negative return. After deducing the market value of listed associates, the value of Singapore Telecom’s core telecommunications and data centre business in Singapore and Optus in Australia is now firmly entrenched in negative territory.”
The following chart shows Singapore Telecom’s share price since we wrote this commentary.
Chart 6: Singapore Telecom Stock Price (May – Jul 2024) Source: OQFM, Bloomberg
We usually focus on what’s going badly. Just as problem gamblers tend to emphasize their wins while glossing over their losses, we believe that poor portfolio managers often downplay risks and focus primarily on what’s working.
We typically do more detailed analysis when things aren’t working, as evidenced by the detailed research note we sent to our investors last month. (If you're on our distribution list, refer to the email sent on July 15 with subject line OQ Insight: Recent Factor Performance in Asia).
However sometimes it’s nice to celebrate wins!
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