A China Affair in Hong Kong

A couple of weeks back, 'A Fund Affair' talked about investing in Chinese stocks. In particular, the different options open to investors who are thinking of putting money into Chinese markets.

In that column, we talked about investing in “A” shares – Chinese companies listed on the Shanghai and Shenzhen exchanges, denominated in yuan. Today, we explore another investment avenue: “H” shares – Chinese companies that are listed and traded on the Hang Seng China Enterprises Index.

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The Hang Seng China Enterprises Index, also known as the H-share index, is a capitalization-weighted index comprised of state-owned Chinese companies listed on the Hong Kong Stock Exchange.

This past week saw the H-share index push back through the psychologically important 10,000 level after it plunged below the 9,000 mark this past March. "The market has been helped by regional gains and Chinese markets are hitting record highs," said Francis Lun, general manager of Fulbright Securities.

In other words, Chinese markets are hot. The H-share index grew an impressive 94% in 2006 and while this year has gotten off to a bumpy start, the market is rapidly making up for lost ground.

If you aren’t familiar with Chinese shares and Chinese markets in general, an option would be to invest in an exchange traded fund or ETF. ETFs are open-ended mutual funds that can be traded at any time throughout the course of the day. Typically, ETFs try to replicate a stock market index such as the S&P 500 or the Hang Seng Index, a market sector such as technology, or a commodity such as gold. Because it trades like a stock whose price fluctuates daily, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund does.

With an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share – i.e. it behaves very much like an individually listed stock. Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order.

An example of an ETF is the SPDR – the Seattle Purebred Dog Rescue – I’m just kidding. Standard & Poor's Depository Receipts, commonly known as “Spiders” (I’m not kidding about that), track the S&P 500 index.

The Fund

The Lyxor ETF China Enterprise Fund (stock code SG:LASI) is listed on the Stock Exchange of Singapore and denominated in U.S. dollars. Sandra Lee, Managing Director and Head of Retail, Marketing and Product Development, Société Générale, which manages the fund explains that like “Spiders” to the S&P index, the China Enterprise Fund tracks the H-share index, providing direct exposure to the biggest 41 Chinese companies listed in Hong Kong.

People like China for many reasons – there is the booming economy and the high levels of foreign direct investment, all of which are enabling companies to grow rapidly. And of course, there’s also the upcoming Beijing Olympics, and the many business opportunities it brings.

“There’s a lot of liquidity in the market, but very few quality Chinese stocks,” Société Générale’s Lee says. Vincent Kwan, Director and General Manager of HSI Services Limited, adds that the beauty of investing through Hong Kong is that Chinese companies that list here must comply with reporting and disclosure requirements that are of international standards. “It's quality control,” Kwan says. “Companies listed on the Hang Seng must meet the standards.”

“H shares are trading now at very reasonable value. And you can exit (Lyxor ETF) immediately if you want because it's traded like a stock,” Lee adds. “It’s an efficient way to gain instant access to all sectors of the Chinese economy.”

The H-share index's top ten components include PetroChina and China Life Insurance.

Hang Seng China Enterprises Index Components

1 PetroChina
2 China Life Insurance
5 Bank of Communications
6 Sinopec
7 Bank of China
8 China Shenhua
9 China Telecom
10 Ping An Life
Courtesy of HSI Services Limited

While there have been some corrections and profit taking, Lee believes that the China story is sustainable despite the fact that Chinese markets are volatile. She notes that people are not exiting the market and that investors can still enjoy decent returns in the long run.

The Affair

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Since listing in October 2006, the Lyxor ETF China Enterprises Fund has gained 36%. However, it is down 2% year-to-date, as is the China Enterprise Index, which it tracks. This is in comparison with the Shanghai Composite Index, which is up 31% on year. Daryl Guppy, a technical analyst and chartist with Guppytraders.com, observes that the H-share index has established a new trend, which is quite dissimilar from Shanghai’s.

Guppy, using a Guppy Multiple Moving Average display, explains that markets are made up of short-term (blue lines) and long-term investors (red lines) who form the foundation of trend behavior.

Guppy notes that the consolidation area for the H-share index between 9,500 and 10,000 was broken when the Shanghai market fell in late February. The H-share index had already been showing trend weakness since early January, so the fall rapidly tested the support level at 8,500. Neither of these levels provided strong resistance in the current rise towards previous high and psychological resistance at 10,800.

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As mentioned in the previous ‘A Fund Affair’ (A China Affair), the charts show no technical barriers to the continued uptrend development of the Shanghai market. However, with the H-share index, Guppy sees a high probability of it lagging behind Shanghai. The Lyxor ETF China Enterprise closed at US$13.00 on Friday.

Please send your questions and comments to us at fundaffair@cnbc.com. We will answer as many of your e-mails as possible on ‘CNBC’s Cash Flow’ airing on Monday, April 16th, 10 am to 12 noon Hong Kong/Singapore time.