China Seeking Foreigners to Tame Stock Market Swings

By Bloomberg News

For most emerging markets, the arrival of foreign equity investors is a harbinger of increased volatility. In China, opening up may be just what the country needs to tame the biggest stock swings in more than five years.
The $4.6 trillion market, where individuals account for about 80 percent of trading, has turned into the most volatile worldwide after Greece as local traders speculate on prospects for increased central bank stimulus. The benchmark index surged 2.9 percent today, erasing an early decline of 1.7 percent.
Chinese policy makers’ desire to increase the role of professional money managers with longer-term investment horizons is one reason authorities are
opening up to foreigners through programs such as the Shanghai-Hong Kong exchange link, according to HSBC Jintrust Fund Management Co. and Bocom International Holdings Co. The recent surge in volatility is adding urgency to that push, says John-Paul Smith of Ecstrat.
“The market overall is in a bad shape right now, you have huge swings which are hard to predict,” Smith, founder of the London-based investment research firm, said by phone yesterday.
The trading approach of Zhang Jing, a 30-year-old private investor who works as a marketing official in Shanghai, helps explain why share prices in China swing so much. Zhang says she doesn’t care about the quality of a company’s management or its earnings prospects. She’s only interested in stock charts: if the pattern looks right, she buys.

Exchange Link

“It doesn’t really matter if the company’s fundamentals are good or not,” she said.
Some 760 miles to the south in Hong Kong, Ronald Chan takes a different approach. The money manager at Manulife Asset Management, who helps oversee about $269 billion and plans to invest in mainland shares through the bourse link that started last month, says he has a team of analysts that interviews company managers, analyzes supply chains and models earnings prospects before deciding to buy a stock.
The exchange connect allows overseas investors to purchase an aggregate 300 billion yuan ($48 billion) of mainland shares, with authorities saying the quota may be increased over time.
China has also expanded its so-called QFII and RQFII investment programs for foreign institutions this year. Investors should act rationally, Deng Ge, a spokesman for the China Securities Regulatory Commission, said in a statement on the agency’s website last week.

New Investors

“The government is highlighting the importance of bringing in institutional investors,” Zhu Haibin, the chief China economist at JPMorgan Chase & Co., said in an interview in Beijing. “Hopefully that will reshape the investor base in the stock market.”
Participation in the exchange link so far has been tepid. International investors have used about 28 percent of the daily quotas of net buy orders allowed through the program, according to data compiled by Bloomberg.
Concerns over ownership rights of shares bought through the link and a requirement for international investors to deliver stocks to a broker before markets open if they plan to sell have curbed participation, according to the Asia Securities Industry & Financial Markets Association.

Relative Valuations

Share prices can be volatile even in the most developed markets such as the U.S., where individuals comprise less than 15 percent of trading according to Tabb Group. The Standard & Poor’s 500 Index (SPX) dropped as much as 1.3 percent yesterday before ending the day little changed.
Price swings in the world’s biggest equity market are still about one sixth the size of those in Shanghai, according to a 10-day reading of historical volatility compiled by Bloomberg. The S&P 500 is valued at 16 times estimated earnings for the next 12 months, versus a multiple of 11 for the Shanghai Composite.
As overseas professionals take larger stakes in Chinese companies, they’ll also push corporate executives to improve the way they treat minority shareholders, said Jerry Feng, the Shanghai-based head of QFII advisory at HSBC Jintrust. China ranked ninth out of 11 Asian nations for the quality of corporate governance in a September survey by CLSA Ltd.
A single overseas investor is allowed to hold as much as 10 percent of a company listed in China, with aggregate foreign ownership capped at 30 percent.
“The shareholder structure will impact corporate governance,” Feng said. “We are on the right track, but the process will be long.”