Maybe Russell should read this --
China funds trade at discounts as foreigners flee
Fri May 18, 2007 4:29 AM ET
By Wei Gu
HONG KONG, May 18 (Reuters) - How overvalued are domestically listed Chinese shares in the eyes of foreigners?
As much as 16 percent, based on two China equity funds for foreigners that trade at discounts to their underlying stocks.
As foreign investors increasingly question whether China's roaring stock market is heading for a crash, overseas-traded China funds which have more than doubled in value in the last year are now steeply discounted.
At the start of the year, the same funds traded at premiums of as much as 20 percent above the value of their underlying stocks, as overseas investors with limited access to A shares listed in Shanghai and Shenzhen crowded into the few vehicles available to them.
"Foreign investors are unwilling to buy A shares at the current price levels," said Joseph Ho, regional director of Barclays Global Investors North Asia, which manages the Hong Kong-listed A50 China Tracker <2823.HK>, one of a small handful of funds developed for ordinary offshore investors to access mainland-listed stocks.
The A50 China Tracker finished April at a price that was 16.6 percent less than the value of its underlying 50 blue chip stocks, including Citic Securities <600030.SS>, China Merchants Bank <600036.SS>, and real-estate developer Vanke <000002.SZ>.
That compares with a premium in excess of 20 percent at the beginning of January, when foreigners flocked to surging China equities.
"Recently demand for A50 has shrunk," said Justin Kennedy, who heads Asia Pacific trading and derivatives at Citigroup <C.N>, A50's market maker.
"Investors are selling it, switching to H shares," he said, referring to shares of mainland Chinese companies traded in Hong Kong.
Because investors are not permitted to short China stocks, some hedge funds that are able to buy mainland-listed stocks short overseas-traded China funds as an imperfect hedge to reduce their risks.
The selling pressure is so big that Citigroup <C.N> said it is impossible to close the gap by intervention.
Since April, Citigroup has been aggressively buying the undervalued A50 funds, redeeming them for A shares, and selling them for a profit in China. The fund is designed in such a way that only the market makers are allowed to redeem the funds' underlying shares.
The intervention has resulted in a 25 percent decrease in total units outstanding and the price gap has been narrowed to 8 percent as of this week.
Citing uncertainty about a capital gains tax, Kennedy said he is also bound by Citigroup's compliance department about how much A shares he can sell.
Similarly, Morgan Stanley's <MS.N> China A-share fund <CAF.N> has been traded at a discount of about 15 percent in late April, compared with a premium of as much as 18 percent in January.
Exchange-traded funds are supposed to closely track their underlying assets because of their built-in arbitrage mechanics. They sometimes trade at premiums in countries where currencies are controlled, reflecting the cost to access that market.
But they seldom trade at steep discounts except during times of turmoil, experts said.
"The change from premiums to discounts reflects the change in foreign investors' expectations," said Zhou Liang, China research manager of fund research firm Lipper.
ONE MARKET, TWO VIEWS
Foreign and domestic investors are sharply divided on China equities, which have risen 50 percent since the start of 2007 and now trade at 60 times earnings. Many foreigners feel they are massively overvalued while Chinese retail investors are still swarming in.
On Thursday, Hong Kong's richest businessman, Li Ka-shing, warned that a bubble had formed in mainland-listed stocks.
"As a Chinese, I am worried about the stock market. With the P/E being 50, 60 times, there is indeed a bubble phenomenon," he told reporters following the annual meetings of his Hutchison Whampoa Ltd. <0013.HK> and Cheung Kong (Holdings) <0001.HK>.
"Of course I do not hope to see a situation when the bubble bursts. It is better for investors to be more careful," he said.
Big foreign investors until recently lined up for Qualified Foreign Institutional Investor (QFII) quotas to invest in the mainland, but recently China has seen surplus QFII quota for the first time, according to CLSA, among the overseas firms allotted a total of $10 billion in quota since 2003.
Even China bulls like Aaron Boesky, chief executive officer of China-focused Marco Polo Investments Group, have become cautious on A shares.
"Cash is very attractive now," Boesky said. "The market needs time for earnings to catch up to valuations."
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