Morgan Stanley's China A-Share Fund: Why Are Investors Panicking?

Apr.20.07 | About: Morgan Stanley (CAF)

The Shanghai-Shenzhen 300 Index plummeted about 4% overnight (with intra-night biggest drop more than 7%) on April 19. In the past three days the discount of Morgan Stanley China A-Share Fund (NYSE:CAF) widened about 3% without any significant drop in the broad Chinese A-share market. Is it because U.S. investors felt the presage about the "eventual downfall" people have been anticipating so much in the A-share market, or rather, is it the unnecessary panic and swing of the discount (or premium) of the CAF relative to its NAV?

The premium and discount of CAF are indeed over-reactionary behavior adding to the already irrational exuberance of the China mainland stock market. A statistical model I performed casually about the predictive power of overnight China 300 index return on the following-day CAF return shows that: when China 300 Index increases, CAF over the next day increases less than what China gained last night -- a "caution" sign of investors about the sustainability of China's bubble. However, when China drops overnight, the reaction is more significant. CAF on average drops more than what China 300 Index drops the night before -- signaling fears of further drop, short-selling, or profit-taking of the China boom craze.

The over-reaction of the investors in CAF is really unnecessary. It only adds extra layer of uncertainty to the only security generally available in the U.S. for people to long or short China A-shares. It adds additional risk from some investors' animalistic mentality, and harms other investors who seriously want to bet on the direction of the Chinese A-share market.

Disclosure: none