HSBC-China Equity Strategy-The AH price gap explained – and how.

Disclosures & Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Issuer of report: HSBC Qianhai Securities Limited View HSBC Qianhai Securities at: https://www.research.hsbc.com Equity Research Report  Two of the biggest factors for the A/H premium: the US Dollar Index, and the difference in liquidity levels in the two markets  When assessing the premium at the stock level, market cap is by far the most important driver  We find that stocks in the value-driven and momentum-driven categories outperformed their benchmarks in the past year What drives the A/H premium. Clients are asking about the A/H share premium. In this note, we explain how it works and how investors can benefit from it. The key factors to consider are (1) that the correlation with the USDX (US Dollar Index) has reached 0.75; (2) that the liquidity difference between the A/H markets – the onshore A-share market (332%) has much higher turnover than the Hong Kong market (66%); (3) that the onshore market has more favourable tax arrangements – onshore investors can enjoy zero-tax for A-share dividends; (4) the investor structure – retail investors drive the onshore market and institutional investors the offshore market – this creates a valuation premium for small-caps in the onshore market and large-caps in the offshore market; and (5) the lack of short-selling tools prevents most A-share investors making a profit from short-selling overvalued stocks, leaving some A-share prices inflated. Across different stocks. Market cap is the key factor here, and we find an inverse relationship (correlation: -0.30) between the market cap and the A/H premium. For example, companies with a market cap below RMB10bn tend to have a much larger A/H premium (230% on average) than companies with a market cap above RMB1trn (31% on average). Correlation with Stock Connect. By analysing the correlation between the A/H premium and the number of stocks under northbound/southbound Stock Connect, we can rank dual-listed companies from extreme value-driven to extreme momentum-driven. For northbound investors, the most value-driven A-shares are CNOOC, Jiangsu Express, and Bank of Chongqing, while the most momentum-driven names are Hepalink, EBSCN, and SWHY. For southbound investors, the most value-driven HK-shares are SPC, Jiangsu Express, and CCCC, while the most momentum-driven HK-shares are Guolian Securities, Shandong Molong, and Dynagreen. Moreover, by grouping the top 10 stocks in each category, we find all four groups outperformed their respective benchmarks during the past year. Two screens for a weakening USD. Based on expected further USD weakening, we believe the A/H premium could narrow. We provide two screens to filter stocks that could benefit from the narrowing A/H premium and enjoy fund inflows from Stock Connect. See page 9. Steven Sun*, CFA (Reg. No. S1700517110003) Head of