A Play on the Hang Seng China AH Premium Index, Which Is Poised for a Rebound

Includes: GXC, PEK
by: China Play Stocks

China A-shares are traded in Shanghai and Shenzhen exchanges, and not available directly to foreign individual investors. China H-shares trade in Hong Kong and are open to foreign investors. The A-shares have historically traded at significant premiums to H-shares. This is because a bulk of the A-shares investors have been individual mainland retail investors who don't have many other avenues to invest their savings; remember, their savings rate is estimated to range from 35% to 50%. These Chinese retail investors are of a speculative bent and tend to chase performance, resulting in wild swings like the bubble of 2007. Mainland retail investors were limited in their ability to invest in H-shares till the recent introduction of the Qualified Domestic Institutional Investor (QDII) scheme. Short-selling was not permitted in the mainland until recently, so there was no way to arbitrage by shorting the A-shares and going long the equivalent H-shares.

The Hang Seng China AH Premium Index is a convenient way to get a handle on the divergence between the prices of the A-shares and the H-shares of the constituent companies. You can download weekly index data from the official website which describes this index thus:

The Hang Seng China AH Premium Index ("AH Premium Index"), a member of the Hang Seng China AH Index Series ("China AH Series") launched on 9 July 2007, measures the absolute price premium (or discount) of A shares over H shares for the largest and most liquid mainland China companies with both A-share and H-share listings ("AH Companies"). Due to the differences in the market characteristics of the Mainland and Hong Kong stock markets - such as different market environments, different groups of investors and the inconvertibility between A shares and H shares - the A-share and H-share prices of the same company generally diverge. The AH Premium Index is designed to provide the market with a simple and easy-to-follow barometer to measure such price differences. It aims to calculate the weighted average premium (or discount) of the A-share prices versus the H-share prices of the constituents, according to the freefloat-adjusted market capitalization of AH Companies.

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This chart shows how the AH premium index has fluctuated wildly over the last four years. Recently, for the first time in 4 years, the index has closed below 100, indicating that the AH premium has vanished when averaged across the components in the index. There are about 44 major blue-chip companies represented in this index, so it is a reasonable representation of the A-share/H-share premium. This is an indication that, at present, the A-share market is reasonably valued.

So, why should you care? Well, it turns out that the AH premium index has some predictive power. Compare the following chart of the Shanghai Composite index (a proxy for the A-shares) with the AH premium index above. It shows that when the AH premium index crossed 100 the last time, it coincided with a bull market for Chinese shares.

(Click to enlarge)

Bottom Line: I believe that the AH Premium Index is just another indicator that the Chinese share market, especially the mainland A-shares market, is poised for a major rebound. If you want to just play the A-shares, buy the ETF PEK. If you want to play China shares in general, go long the ETF GXC which covers large-cap and mid-cap China shares.

Disclosure: I am long PEK, GXC.

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