Few anticipating a repeat of A-shares boom and bust

A more than 14% rally by China A shares during the first week or so of July left some observers asking whether a replay of the manic bull run the mainland experienced five years ago could be in store.

But a lot has changed since that dramatic runup which saw Shanghai and Shenzhen's composite stock market indexes more than double in less than a year, making another retail-driven, margin lending-fueled rally with an unhappy ending less likely, market participants say.

In the interim, access for foreign investors to mainland-listed A shares has improved considerably and an initial 3% to 4% of the Shanghai and Shenzhen markets have been added to leading benchmark indexes — with further additions likely in coming years.

Meanwhile, China's regulators continue to give domestic institutional investors, like insurers, ever greater leeway to allocate their fast-growing pools of capital to equities — creating a growing, if still small institutional counterweight to retail investors that account for well over 80% of overall market activity.

Another key difference is the continued development of the broader equity market, including progress in building out a derivatives market on the mainland investors can use to hedge their exposures, said Paul Sandhu, BNP Paribas Asset Management's Hong Kong-based head of multiasset quant solutions and client advisory.

However for a number of analysts, the biggest change from five years before is the heightened vigilance of China's powerful regulators, which were forced to scramble in 2015 as the market peaked on June 12 and then plunged more than 40% over the 10 weeks that followed.

"Policymakers' attitude toward the stock market" is a key difference relative to 2015, said Kinger Lau, Hong Kong-based managing director and chief China equity strategist with Goldman Sachs & Co.

"They are arguably more ahead of the curve this time around in terms of containing speculation and are more vigilant about risk management, which means that the dramatic boom/bust episode of 2015 is less likely to repeat, at least from a policy/expectation management standpoint," Mr. Lau said.

In a July 7 "China Musings" report on the prospects of a "summer melt-up" for the A-shares market, Mr. Lau and his Goldman Sachs colleagues made the case for just another 15% upside for mainland stocks over the next three months. On the back of lower earnings growth estimates for the coming year, the report predicted most of that final advance would evaporate by June 2021.

China's domestic stock markets today "are much better regulated, with a stronger structure than in 2015," agreed Cheah Cheng Hye, co-chairman and co-chief investment officer of Hong Kong-based Value Partners Group Ltd., which reported $11.8 billion in assets under management as of June 30.

As a result of the lessons learned from the stock market crash of 2015, regulators are striving to ensure that the market remains orderly, Mr. Cheah said.

By way of example, he pointed to a July 8 order issued by the China Securities Regulatory Commission shutting down 258 "illegal margin-lending platforms."

The government stepped in early "to tackle the bubble," in contrast to 2014, when margin financing was allowed to build up to 2 trillion yuan and market sentiment became euphoric, said Eng Teck Tan, a Singapore-based senior portfolio manager with Nikko Asset Management Asia Ltd. This time around, a battle-hardened government and regulatory regime have much clearer views regarding the strategic importance of a healthy stock market, he said.

The day after those margin lending platforms were squashed, the Shanghai Stock Exchange composite index crested at 3,450.59, and has since declined by 7.4% through July 24. The Shenzhen Stock Exchange composite index topped out four sessions later, closing at 2,329.40 on July 13, but then dropping 8.2% through July 24.

Meanwhile, as a key to laying the groundwork for a less volatile trading environment, regulators continue to work to attract more long-term money to the A-shares market, analysts say.

The latest example came on July 17, when the China Banking and Insurance Regulatory Commission announced that the ceiling on insurers' total equity allocations — public, private, domestic and overseas — would be lifted to as much as 45% of their portfolios from 30%.

Regulators are all in favor of a bull market but "they don't want to have a crazy bull market, followed by a market crash," and attracting more insurance capital to the market is in line with that goal, said Rick Wei, Hong Kong-based head of insurance for Asia ex-Japan with J.P. Morgan Asset Management.

CBIRC's latest revisions do away with its previous "one-size-fits-all" approach, setting the same equity allocation ceiling for all insurers, to one that imposes different limits in accordance with an insurance company's solvency levels and risk management capabilities, Mr. Wei said.

China's top five insurers, accounting for well over 60% of industry assets based on their general account assets, currently allocate between 16% and 20% of their capital to public and private equity, with the average for the broader industry at roughly 22%, he said.

Mr. Wei predicted higher allocation ceilings could see insurers investing trillions of yuan more into equities in coming years, especially if Chinese government bond yields, currently around 3%, continue to fall.

"The market is institutionalizing," said William Chuang, a Hong Kong-based portfolio manager, Asia equities, with AXA Investment Managers, citing the expanding A-shares opportunities for insurers as they face pressure to garner higher returns and the Chinese government's launch over the past two years of pilot programs for tax-deferred retirement schemes as examples.

Foreign ownership of A shares, meanwhile, has risen to as much as 4% of the market, up sharply from less than 1% before China launched the Hong Kong Stock Connect program in late 2014, Nikko's Mr. Tan said.

Still, even as long-term investors' weight in the A-shares market has risen to roughly 11% to 12%, retail investors remain the dominant players in Shanghai and Shenzhen, analysts say.

With almost 1,000 new China A company listings over the past five years, "both the quality and the quantity of the China equity universe (continue) to improve — unlike the rest of the world where equity markets are shrinking," noted Anthony Wong, a Hong Kong-based portfolio manager overseeing at Allianz Global Investors' China equity strategies. But with retail investors accounting for more than 80% of turnover, "we're still at the relatively early stages of a long-term journey in the development of Chinese capital markets," which remain significantly inefficient, he said.

What that dominance of retail investors "means for us" is ample mispricing opportunities to take advantage of, said Ben Sheehan, a Hong Kong-based senior equity investment specialist, Asia-Pacific, with Aberdeen Standard Investments. The market will inevitably become more institutional but it will remain a target-rich environment for active managers over the coming decade, he predicted.

Aberdeen's A-shares fund has seen assets under management jump to $3.7 billion as of July 22 from $3.3 billion at the end of June and $2.6 billion in June 2019.

Still, even on the retail side, some analysts see hopeful signs.

China's authorities and industry associations have become much more sophisticated over the past five years, and the same can be said about individual investors on the mainland, where education efforts have emphasized the benefits of long-term investing as a means of combating the longevity issue, said Janet Li, Mercer Investments' Hong Kong-based wealth business leader for Asia.