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Capturing pricing anomalies: China A- and H-shares (part 2 of 2)

In our previous posting on China A and H shares, we discussed the pricing differential on dual-listed Chinese stocks—those listed both domestically (A-shares) and in Hong Kong (H-shares). We explored how to potentially construct a transparent index methodology that could take into account such pricing anomalies. The simulated A/H index is expected to outperform the market-cap weighted China A-shares benchmark when the A/H share pricing differential converges and underperform when the differential diverges. Now, let’s see if the simulated performance supports our expectation. 

Empirical evidence suggests a convergence/divergence pattern where the prices of the two markets diverge at times but tend to converge when the price gap becomes wide enough. As demonstrated in part 1 of the series, A-shares have most often traded at a premium to their H-share counterparts.  As we can see below, the simulated China A/H Index has outperformed the FTSE China A Index over a 10-year period. This indicates that the A/H switching mechanism is able to capture the A/H price anomaly historically.

In addition, the simulated A/H Index has exhibited less volatility than its market cap benchmark. As seen below, these results hold true over the three-, five- and ten-year time horizons. The A/H switching mechanism appears to have successfully captured the A/H price anomaly—but at what cost?

As discussed in part 1 of this series, the construction of an A/H index would include switching to the cheaper of the two listed prices at each rebalancing date. We used an assumption of quarterly rebalancing periods with a 3% buffer zone around the pricing anomaly threshold.

When rebalancing a simple market cap weighted index like the FTSE China A Index, turnover is completely attributable to changes in the underlying market cap of its constituents. For the A/H Index, the turnover is attributable to both the underlying market cap changes and the share switching—making annual turnover within the index significantly higher.

An analysis starting in June 2007 demonstrates that the average annual turnover for the simulated A/H index was 55.2% versus just 18.5% for the FTSE China A Index.  Market participants would need to take into account the impact of a higher turnover in their assessment of an A/H index for a more complete understanding.

In February 2016, FTSE Russell launched the FTSE China A-H50 Index based on the FTSE China A50 Index which is a smaller subset of only the largest dual-listed Chinese companies. Even when the higher turnover associated with capturing the A/H pricing anomaly is considered, the  index may be of interest to market participants.

For further details on capturing the China A- and H-share pricing anomaly, see the corresponding FTSE Russell Insights paper.


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