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Investors keep cautious views on QFII expansion

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The move has caught the attention of the international media and points to a renewed sense of purpose regarding the Chinese authorities attitudes towards capital market reform. However, the increase still only brings the QFII quota to 3% of total A-share market capitalisation and questions of transparency and due diligence still dog mainland markets.

 After 2011’s freeze on QFII quota expansion, foreign institutions have by and large welcomed the recent $50bn expansion to an $80bn total. The RQFII quota was also expanded by $50bn to $70bn and participants can now to offer A-Share ETFs through the scheme.

 The pace of awarding quotas also picked up markedly, with the State Administration of Foreign Exchange having issued over $700m in quotas to five institutions in the first two weeks of April. Julian Liu, CEO of Polaris Securities in Taiwan, which was awarded $100m QFII quota in December 2011, says: “The financial regulators are trying to make the structure of local capital markets healthier.”

 “It’s a new catalyst to boost mainland markets and a way for institutional investors to participate in China’s capital markets.”

Yi Tang, GM and CIO at Edmond de Rothschild Asset Management in Hong Kong, one of the earliest QFII participants, says the impact of the recent expansion were as much in terms of sentiment as material. “Increased QFII A-share investment will boost market sentiment and reflects the continued orderly development of macro-economic policy. It will undoubtedly have a long-term impact on the market, but the actual short-term effects are limited.”

 Hubert Tse, a partner at Chinese law firm Boss & Young in Shanghai, who advises multiple QFIIs, argues that demand is still strong for increased China exposure among foreign institutions, and there is scope for the quota expansions to continue as China’s securities markets are gradually being opened up to foreign investors. “Current QFIIs should be able to increase quotas and many are interested in doing so. There is still tremendous demand for Chinese securities which is not yet met.”

 In terms of investment strategies, most QFIIs appear to favour tailoring their exposure to China’s industrial policy as outlined in the 12th Five-Year Plan, which privileges sectors such as clean energy, new media and consumption stocks. QFII investors tend to prefer dividend-paying blue-chip names, Tse observes.

 However, EdRAM’s Tang maintains finding good investment opportunities is “relatively easy” in terms of stock selection because the A-share market is more diverse and the index is less top-heavy than other forms of China exposure, such as H-shares. EdRAM favours non-bank financials, oil and energy and heavy manufacturing equipment, on the prospects of pricing reforms and the need for further investment in infrastructure.

 Despite the macro risks, with expertise in individual stock selection, investors can mitigate downsides. “On the long-term, we’re very positive about specific names if they match our strict valuation criteria,” Tang says.

But investors retain a cautious view on Chinese equities, in the short term at least. Polaris’ Liu argues “the China index is moving sideways, and we don’t see huge upside in the near future. On the other hand, the downside is limited. However, it could be a good entry point because rebalancing is occurring and we see opportunities in sectors related to consumption, marketing and new infrastructure.”

 Liu adds: “Another risk for foreign firms is a lack of knowledge and research capabilities. We need to become more familiar with Chinese markets. From this perspective, I would say even Taiwanese and other local investors are in the same boat as their Western counterparts.”

EdRAM’s Tang argues with valuations at historical lows, the downside market risk is relatively low, and investors should worry more about specific risks such as corporate governance, corporate integrity and industry-specific risks.

 Boss & Young’s Tse also points to market deficiencies as a source of risk for QFII investors. “There are still a lot of SOEs which are hard to read, markets remain quite immature, volatile and react heavily to rumours, partly because there’s still a high proportion of retail investors compared to institutions.”

 As such, the expansion of QFII and RQFII is not enough to push A-share markets out of the doldrums on their own, but it does signal a clearer direction for the long-term evolution of China’s capital markets.

Moreover, it gives institutional investors renewed impetus to focus on and improve their understanding of Chinese securities markets after a torrid 36 months which has left many questioning China’s long-term growth prospects.

 However, Chinese markets remain fraught with difficulties for foreign institutional investors, and most lack the necessary on-the-ground research and analytical capabilities to profit fully from A-share opportunities. And for the time being, Chinese securities will continue to exist with a high degree of insulation from global market movements.

 “One day we’ll get to an advances stage of integration but this is not an increase of sufficient magnitude. Despite the expansion, China’s markets have not yet opened up to the state whereby mainland equities move in tandem with other markets. They still have their own fundamentals and are subject to government policies,” Tse concludes.

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