At the start of the Year of the Ox, the stock has been surging, and the Hang Seng Index has returned to 31,000, the highest in 2.5 years.

Over the past two years, Hong Kong stocks and mainland stocks that are listed in Hong Kong have been lagging behind A-shares. But recently Hong Kong stocks have been rallying, thanks in part to funds from the north. Why are mainland funds flooding into the Hong Kong stock market? I believe there are several reasons. First, in terms of valuation, Hong Kong stocks are cheaper than A-shares. Some companies listed in the mainland and Hong Kong have even greater A share-H share differences. Thus, mainland funds are attracted to the Hong Kong stock market.

Second, the flood of mainland funds to Hong Kong is a response to monetary policies. Although the Chinese economy was hit by the coronavirus pandemic in the first half of last year, it made a rapid recovery in the third and fourth quarters, and the monetary policy of the People’s Bank of China has gradually gone from being loose to neutral. It has not been tightened, but because A-shares are always more sensitive to monetary policies in general, mainland investors have moved to Hong Kong, where the monetary policy is still loose.

The third reason has to do with exchange rate. A few years ago, when the renminbi was relatively weak, it was rather hard for funds to flow to offshore markets. But as the Chinese currency against the US dollar continues to go up, even if funds flow to the Hong Kong stock market, things are still controllable for the regulatory authority.

Fourth, the range of products in the market has further expanded. Since the beginning of the year, some Hong Kong exchange-traded funds (ETFs) have been launched in the mainland, so that Chinese investors have been able to get into the Hong Kong stock market in a simple way. The ETFs are widely popular, and the trend has directly stimulated the Hong Kong stock market. In particular, some big stocks and Hang Seng Index Constituent Stocks have been going strong.

Mainland investors usually come and go quickly. Will the latest wave of funds flowing into the Hong Kong stock market be just short-term or long-term? It seems the aforementioned inflow of funds and the rising renminbi exchange rate are short-term phenomena. Nevertheless, we cannot ignore the emergence in the Hong Kong stock market of some favorable structural factors.

Since the 2009 financial crisis, indices related to the Hong Kong stock market, such as the Hang Seng Index and the MSCI Hong Kong Index, have been lagging behind their American counterparts. One reason is that the US stock market has plenty of technology companies that rock the world and grow rapidly, whereas the Hong Kong stock market has long been led by companies from the traditional old economy, such as property developers, banks and telecommunication companies. These sectors grow more slowly, and the stocks of some Chinese bank have been dragged down by bad debts. Therefore, even if the valuation of these stocks is low, they can hardly attract capital.

Fortunately, the situation has gradually changed in recent years. Amid tension between China and the US, many Chinese ADRs (American Depositary Receipts) have returned to Hong Kong to be listed on the stock market here. Most of these companies belong to the new economy. Meanwhile, more and more mainland technology startups are coming to Hong Kong for direct listing. This has changed the landscape of the Hong Kong stock market. These healthcare, technology and biotechnology stocks have higher growth potential, and some have even become Hang Seng Index Constituent Stocks, so that stocks belonging to the new economy now account for about half of the index. In this regard, it is reasonable for the valuation of Hong Kong stocks to go up. As for other reasons, I will explain next time.

(Chung Sau Ha is a senior portfolio manager with Allianz Global Investors.)

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