China optimism prompts record inflows into Hong Kong exchange-traded funds

NEW YORK (Bloomberg) - An unprecedented amount of money is flowing into the largest exchange-traded funds that track Chinese companies listed in Hong Kong as investors bet the biggest rally in more than three years will continue.

The Hang Seng H-Share Index Fund lured HK$20.5 billion (S$3.52 billion) in April, the largest monthly inflow since at least 2010 and the third-most among equity ETFs globally, according to data compiled by Bloomberg. About HK$29 billion has been added to the fund during the past four months in the longest stretch since 2013 as assets grew to HK$57.1 billion.

Chinese companies trading in Hong Kong will narrow the discount to their dual-listed counterparts on the mainland as the rally spreads to the so-called H-shares market amid expectations for more monetary easing in the world's second- largest economy, according to UBS AG. While the Hang Seng China Enterprises Index soared 17 pe rcent in April, the most since October 2011, A shares in China are still trading at a 31 per cent premium to stocks in Hong Kong.

"The H-share market still has room to go higher based on momentum and liquidity with the monetary easing measures," said Jorge Mariscal, chief investment officer for emerging markets at UBS in New York. "That valuation gap between A and H shares is going to close. Investors are expecting the monetary easing will continue, and the economy will stabilize down the road."

The Hang Seng China Enterprises benchmark has climbed 48 per cent in the past year compared with a 119 per cent advance in the Shanghai Composite Index's A shares. Both gauges ended last week near seven-year highs. A Bloomberg index of the most-traded Chinese stocks in the U.S. rose 0.5 per cent on Friday, paring a weekly loss to 1.5 per cent, on a day when markets in China were closed for a holiday.

Mainland stocks have rallied as investors took advantage of the Shanghai-Hong Kong exchange link and low valuations while anticipating the beginning of looser monetary policy. The People's Bank of China cut interest rates and reduced banks' reserve requirement ratios twice in the past six months in an attempt to prevent a deeper slowdown as the economy is forecast to expand 7 per cent this year, the weakest pace since 1990.

The MSCI China Index ETF also attracted record inflows in April as investors added HK$1.2 billion, the most since the HK$4.1 billion H-shares fund began trading in Hong Kong in 2001. U.S. investors also boosted their H-share positions through the iShares China Large-Cap ETF which grew by US$385 million in April, the biggest inflow in eight months.

The Hang Seng H-Share ETF rose 17 per cent in April to HK$145.20 in a third month of gains while the MSCI China fund surged 16 per cent to HK$26.90. The iShares China Large-Cap ETF also jumped 16 per cent last month in New York. It rose 0.9 per cent to US$51.80 on Friday.

The Hang Seng H-share measure, which mainly includes China's big state-owned companies, is valued at about 10 times forward earnings. That compares with a multiple on the Shanghai Composite Index of 17, up from 7.5 a year ago, data compiled by Bloomberg showed.

China's stock markets may be vulnerable to a pullback in the near future, even amid an extended rally, as the underlying economy catches up with equity prices, according to Michelle Gibley of Charles Schwab Corp.

"Chinese stocks may have moved too far, too fast in the short term, but may potentially be early in a longer term move higher," Gibley, the director of international research at San Francisco-based Charles Schwab, wrote by e-mail. "Typically during a shift in monetary policy, valuations expand first, then fundamentals."

While China's official Purchasing Managers' Index, based on surveys of larger manufacturers, stayed at 50.1 in April, the preliminary reading of another PMI from HSBC Holdings Plc and Markit Economics for smaller businesses slid to a one-year low of 49.2. A reading above 50 indicates expansion.

Premier Li Keqiang said in March that the nation will roll out more measures to support growth if employment is at risk. The state council announced more tax breaks and subsidies to some enterprises to support job creation last month.

"The central bank is taking measures to boost the economy by providing support through the policy banks, who lend to the large state-owned enterprises," Clem Miller, an investment strategist at Wilmington Trust, which manages $80 billion, said by e-mail. "The shares of these enterprises dominate the H- shares market, and investors expect these shares to appreciate."