Zaks Investment Advisory Service

On Chinese Stocks and Exchanges

Last time, I started to talk about the economy and stock exchanges of China. I mentioned that its economy has been experiencing extremely strong growth since the early 90s, while the stock prices have only been growing for the past two years; before then, for many years, stock returns remained depressingly low. The situation changed after Chinese authorities (or more precisely, the Chinese equivalent of the Securities and Exchange Commission) introduced reforms that made stock exchange operations more transparent while reducing the influence of state companies. The market responded enthusiastically to these reforms and has grown by more than 300 percent over the past two years.

The structure of Chinese exchanges is fairly complex, and investors often fail to clearly understand how they can invest in Chinese markets. Sometimes, having made their investments, they do not know what it is they actually hold. The problem is that the Chinese government regulates which company shares may be purchased by foreigners, and which ones are set aside only for citizens of the Chinese Democratic Republic (the so-called A and B shares). Moreover, the Hong Kong exchange also trades shares in Chinese companies (these are called H shares). And some Chinese companies have issued so-called ADRs (American Depository Receipts) on the New York exchange, where they may also be bought (these are sometimes called “N shares”). Let us try to make sense of all this.

Continental China has two stock exchanges: in Shanghai and Shenzhen. The Shanghai exchange was founded in 1891 but shut down in 1949 after the Communists’ rise to power. It was again reopened in 1990, and now the Shanghai exchange is China’s largest: the value of all shares traded in Shanghai is approximately 2.5 trillion dollars. Shenzhen, meanwhile, is a new city whose main advantage is that it borders Hong Kong. Until 1979, Shenzhen was a fishing village. In 1979, Deng Xiaoping decreed that one of China’s free economic zones be established there, and the city has been growing like a weed ever since. Now, it has a population of six million people. The Shenzhen stock exchange was founded in 1990, the same year that the new Shanghai exchange was re-launched. The Shenzhen exchange is about five times smaller than the one in Shanghai: the value of all its shares is about 500 billion dollars.

All of the shares on the Shanghai and Shenzhen exchanges are separated into two classes. Class A is theoretically only accessible to citizens of China (there are certain exceptions to this rule, which I will talk about later). They are traded in yuans, the national currency of China. Foreigners may only purchase Class B shares, which are denominated either in the US dollars (in Shanghai) or in Hong Kong dollars (in Shenzhen). In recent years, Chinese citizens have also been allowed to purchase Class B shares, but only if they hold dollar accounts. Companies whose shares are listed as Class A do not essentially differ from companies whose shares are listed as Class B. Moreover, a number of companies have shares with both Class A and Class B listings. Chinese authorities understand that this is an artificial and economically inefficient segregation. Plans to merge the two classes have been around for a long time, but nothing has been accomplished yet. Because these classes have different buyers, Class A and Class B shares perform differently. For example, Class A shares grew by 250 percent over the past five years, while Class B shares (in other words, the ones invested in by foreigners) – by about 180 percent. On the other hand, looking at the past two years, one finds that Class A shares grew by about 360 percent, while Class B shares – by 440 percent.

Chinese company shares are also traded on the Hong Kong exchange. These are called Class H. Usually, shares on the Hong Kong exchange are issued by China’s largest companies, ones like the China Mobile telephone company, the oil major PetroChina, and so on. Just as the Class A and B shares don’t trade in tandem, so the Hong Kong Class H index performs differently from its continental brethren. For example, over the past 12 months, Class H shares gained about 80 percent, while Class A shares – about 150 percent. Of course, this does not mean that Class A shares will continue to outperform Class H shares in the future.

Besides Chinese and Hong Kong exchanges, shares of some Chinese companies are also traded in New York. For example, the above-mentioned PetroChina at one point issued ADRs (American Depository Receipts) that may be purchased in New York. Until recently, PetroChina shares were quoted simultaneously on two exchanges: in New York and Hong Kong. And short while ago, PetroChina also issued shares on the Shanghai exchange. In Shanghai, these shares are listed as Class A, i.e. they are only traded in yuans. As a result, PetroChina’s shares may now be purchased on three different exchanges: in New York in American dollars, in Hong Kong in Hong Kong dollars, and in Shanghai in yuans. In terms of market capitalization, PetroChina has become the largest company in the world: if one takes the stock prices in Shanghai as the basis (PetroChina’s shares are priced differently on the various exchanges), then the market value of PetroChina is around a trillion dollars, double that of ExxonMobil, the largest American company.

I would like to note that prices on Chinese shares are very volatile. Many believe that they are overvalued and may soon suffer a big fall. They have, in fact, lost about 15 percent in the past two months. On the other hand, they have nearly doubled since the start of the year, while the S&P 500 index stands practically at the same mark it was on January 2. In either case, you should consult your investment advisor before buying Chinese shares.

And with this, we will draw today’s program to an end. This was Sergey Zaks. Thank you for your attention and until next time.