China's A, B and H Shares

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Hank Moody
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China's A, B and H Shares

Post by Hank Moody » Tue Mar 01, 2016 12:54 am

I've been reading up on Vanguard's decision to include China's A shares in VWO. Please help me understand something: I know that there are A shares, B shares and H shares. I also realize there are certain differences between these classes but I don't understand why the A class is any riskier than the others for a given company. Maybe I'm framing my question incorrectly, but can someone give me a deeper understanding of the Vanguard issue and why these share classes matter?

Also, if Vanguard says that 27.7% is invested in China, how do we ascertain the breakdown of share classes?

https://personal.vanguard.com/us/funds/ ... =INT#tab=2

Thank you,
HM
-HM

BritAbroad
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Re: China's A, B and H Shares

Post by BritAbroad » Tue Mar 01, 2016 1:17 am

Hi Hank, it depends what kind of risk you're looking at. H shares trade in HK and are subject to different rules/regulation from the mainland market. Of the three, H shares will often have the best level of investor disclosure/transparency. H shares are widely held by international (institutional) investors, so the market dynamics are much closer to what you'd expect in the rest of the world. B shares are little used nowadays so may suffer from poor liquidity & volatility, many B shares are converting/have converted to A shares. A shares are dominated by the local, retail market (80% retail, compared to HK which is 80% institutional), an effect of this retail dominance is huge volatility & snowballing effects; there's an easy disconnect between fundamentals and pricing (large amounts of speculation).

Dirghatamas
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Re: China's A, B and H Shares

Post by Dirghatamas » Tue Mar 01, 2016 1:26 am

Actually you forgot one more (very important) share class: N shares. Here is the way to think about it

1) Many large/upcoming Chinese companies who wanted world wide capital, listed on the New York Stock exchange. These are high profile companies like Alibaba, Baidu etc. These should technically be part of US stock market going by the definition of what "US stocks" are e.g. Pfizer is considered a US company. For X,Y,Z reason, the index providers ignore these companies from US stocks. They also ignored them from International stocks and even from emerging market stocks. Some index providers (MSCI) are now starting to include them. Vanguard isn't. If you use Ishares/Blackrock in any of your holdings, you will get them.

2) H shares are shares listed in HongKong. Originally HongKong was British and had a different currency pegged to the US dollar. This stock exchange allowed foreigners to hold shares. All index providers include these shares. There is nothing really controversial about these except whether they should be included in "developed" or "emerging" market. Technically, China is considered emerging, but HongKong is considered developed but HongKong is ~now part of China so which is it :?

3) A shares. This is the main new controversy. There are two main Chinese stock markets Shanghhai and Shenzen. These mostly list the smaller/local Chinese companies. Till recently, foreigners couldn't hold these shares. On the other hand, most Chinese can't really hold "foreign" shares so these are the main shares they owned. These stock markets are the wild west with rules changing every few months, Government disallowing short selling and all kinds of "momentum" based trading. The kindest way to describe these would be "growing pains". To add even more confusion, many companies have both H shares and A shares. No they are not of same value due to a variety of reasons.

As of this year, all fund companies have HongKong based shares in all index funds: world stocks, international stocks, emerging markets etc. Vanguard emerging (but not International or world stock) will include A shares by the ends of this year but not N shares. BlackRock/iShares and some other fund companies will have N shares but not A shares.

As you can see there is a lot of "interpretation" in actual enactment of index funds. There appears to be nothing automatic about how to handle China in index funds.

Coles
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Re: China's A, B and H Shares

Post by Coles » Tue Mar 01, 2016 3:13 am

Dirghatamas wrote:Originally HongKong was British and had a different currency pegged to the US dollar.
There has been no change in Hong Kong's currency since World War II and the US dollar peg implemented in 1983 remains in effect to this day (with minor tweaks).

Additionally, your use of the word "originally" is historically inaccurate. Perhaps you meant "previously"?

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in_reality
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Re: China's A, B and H Shares

Post by in_reality » Tue Mar 01, 2016 3:54 am

Which shares currently have restrictions on selling them? Would that be the H shares that large sellers can't unload without disclosing it a few weeks in advance? Or is that all shares? Anyone know?

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Hank Moody
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Re: China's A, B and H Shares

Post by Hank Moody » Tue Mar 01, 2016 9:18 am

Let me refocus my OP. What is the difference in risk and return between A and H shares? Are these different companies?
-HM

larryswedroe
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Re: China's A, B and H Shares

Post by larryswedroe » Tue Mar 01, 2016 9:21 am

Hank
The biggest difference is in the P/E ratios, about 4x higher I think in A vs H shares!! And that's after the bubble started to burst
Larry

lack_ey
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Re: China's A, B and H Shares

Post by lack_ey » Tue Mar 01, 2016 11:20 am

Hank Moody wrote:Let me refocus my OP. What is the difference in risk and return between A and H shares? Are these different companies?
There's some overlap, with companies listed both on the mainland exchanges and in Hong Kong. Because of the restrictions, it's very possible for stocks to trade at significantly different valuations on the two markets (read: A shares more expensive). But a lot of companies, particularly smaller ones, are mainland only, A shares.

The A shares market is dominated by a first generation of individual investors who largely have demonstrated little understanding of fundamentals. We're used to markets driven largely by algorithmic trading, mutual fund and hedge fund managers, pension funds, other professionals. Not the case here, for sure. These issues and the higher valuations should drag down future returns, at least eventually. It has been markedly inefficient, and for sure it is significantly more volatile than the H shares market, which behaves more like most other markets around the world.

garlandwhizzer
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Re: China's A, B and H Shares

Post by garlandwhizzer » Tue Mar 01, 2016 12:12 pm

Over a significant timespan it is assumed by many that the Chinese government will liberalize their financial policies, that Chinese investors in A shares will learn a bit more about investment fundamentals, and hence that A shares and H shares will tend to move toward a median in valuation and volatility. How fast that occurs, or even if it will be successful, is not entirely clear. That is responsible for some of EM's recent volatility because China's cap weight dominates EM indexes and its GDP dominates other EMs.

As Larry points out, A share valuations (expensive) are much less attractive than H shares (cheap) even for stocks that listed on both because A share stock prices reflect both inexperienced Chinese investors and the many fewer investment alternatives that they have presently under the government's regime. I have heard that Goldman Sachs is the firm that is advising the Chinese government on how to liberalize and make transparent their equity markets without creating severe macroeconomic damage in the process. Clearly there are growing pains in this transition as the recent collapse of A shares demonstrates. Creating free and open markets in a place that has never had them is a painful and volatile process. But pain is something that China, unlike the lucky US, has learned to tolerate time and again over many centuries. I believe that in the end, whenever that is, they'll emerge from all these troubles with more stable, more open, and more transparent financial markets. The decision by Vanguard to start holding some A shares rather than just H shares suggests that they believe that this process will move along at a good pace and without undue disasters.

Garland Whizzer

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Hank Moody
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Re: China's A, B and H Shares

Post by Hank Moody » Tue Mar 01, 2016 12:16 pm

If A shares are thought to offer a poorer risk/return tradeoff, what is Vanguard's argument for inclusion?
lack_ey wrote:
Hank Moody wrote:Let me refocus my OP. What is the difference in risk and return between A and H shares? Are these different companies?
There's some overlap, with companies listed both on the mainland exchanges and in Hong Kong. Because of the restrictions, it's very possible for stocks to trade at significantly different valuations on the two markets (read: A shares more expensive). But a lot of companies, particularly smaller ones, are mainland only, A shares.

The A shares market is dominated by a first generation of individual investors who largely have demonstrated little understanding of fundamentals. We're used to markets driven largely by algorithmic trading, mutual fund and hedge fund managers, pension funds, other professionals. Not the case here, for sure. These issues and the higher valuations should drag down future returns, at least eventually. It has been markedly inefficient, and for sure it is significantly more volatile than the H shares market, which behaves more like most other markets around the world.
-HM

lack_ey
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Re: China's A, B and H Shares

Post by lack_ey » Tue Mar 01, 2016 12:26 pm

Hank Moody wrote:If A shares are thought to offer a poorer risk/return tradeoff, what is Vanguard's argument for inclusion?
Well, this is the same company that's pushing hedged international bonds like crazy despite current yields being lower (and not completely compensated for by USD hedge return).

They're just taking the long view. Over time presumably the market will get less crazy. This speaks to diversification and greater representation of world markets, covering all the bases.* China is many steps away from opening up their markets, and before that happens, the fund's slice of A shares exposure will be at a reduced level, 5% I think it was. Only eventually will they move to market cap weighting.

*except, you know, as Dirghatamas pointed out, they're skipping N shares for whatever reason, so no Alibaba or Baidu for us.

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Re: China's A, B and H Shares

Post by larryswedroe » Tue Mar 01, 2016 2:11 pm

Hank
Note when DFA began to include China it only would buy the Hong Kong shares

Topic Author
Hank Moody
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Re: China's A, B and H Shares

Post by Hank Moody » Tue Mar 01, 2016 2:38 pm

I actually researched it and found that their current holdings exclude A shares too. Their EM funds have a 15% allocation to China, and nearly all is traded on the HK exchange.
larryswedroe wrote:Hank
Note when DFA began to include China it only would buy the Hong Kong shares
-HM

Dirghatamas
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Re: China's A, B and H Shares

Post by Dirghatamas » Tue Mar 01, 2016 3:38 pm

Hank Moody wrote:If A shares are thought to offer a poorer risk/return tradeoff, what is Vanguard's argument for inclusion?
That's the big question, isn't it? When they announced the change, they actually had a blog and video about all this. I watched it and wasn't convinced at all about the logic. Basically lets say there are 3 share classes with some duplication: H shares in HongKong, N shares in New York and A shares in Mainland China. Most people would grade the legal/non-financial risk as H less risky than N than A. One could argue about H vs. N. The reason N shares should be considered risky is that some of the companies are actually incorporated in the Caribbean islands rather than USA or China. Fair enough.

So till last year all typical passive index funds a Boglehead would use, only had H shares. All index providers looked into including more share classes last year. MSCI as (in some sense) the leading index provider, decided to punt on A shares due to obvious governance issues. They actually drew considerable flak from the Chinese Government about this. They decided to include N shares instead. Vanguard decided to include A shares but gave no logical explanation about N shares...They simply ignored it without any explanation. It is what it is. You can deal with it or chose a different fund.

The simplest way to avoid A shares is to just use total market funds like Vanguard Total International or Vanguard World Stock. This is what I do by investing globally, passively. Thankfully, Vanguard decided to not include any of these high risk classes in the total market funds. If you want to tilt to emerging markets but want to avoid A shares, simply use a low cost fund company that uses MSCI as the index provider. You can find them at BlackRock and Schwab as just two examples. I don't remember what Fidelity does.

Topic Author
Hank Moody
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Re: China's A, B and H Shares

Post by Hank Moody » Tue Mar 01, 2016 3:41 pm

Great answers, guys. Thank you very much!
-HM

Northern Flicker
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Re: China's A, B and H Shares

Post by Northern Flicker » Tue Mar 01, 2016 3:42 pm

Vanguard's publicly expressed rationale for including A shares is that H shares offer much less diversification opportunity across industry sectors and individual companies, so that A shares provide exposure to substantial GDP otherwise excluded.

With the Shanghai and Shenzen exchanges dominated by speculative retail investing and gov't intervention, who knows what fair market value is for a China A security? It is thus impossible to know whether opacity risk and other risks in these markets are being discounted in, or at what level they should be. I think VG is moving too early on this, but they know more about A shares than I do.

I suspect VG will ultimately add A shares to the total world/int'l funds, but ishares IXUS (total int'l index) has an ER competitive with Vanguard ER's.

Dirghatamas
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Re: China's A, B and H Shares

Post by Dirghatamas » Tue Mar 01, 2016 3:54 pm

Coles wrote:
Dirghatamas wrote:Originally HongKong was British and had a different currency pegged to the US dollar.
There has been no change in Hong Kong's currency since World War II and the US dollar peg implemented in 1983 remains in effect to this day (with minor tweaks).

Additionally, your use of the word "originally" is historically inaccurate. Perhaps you meant "previously"?
Look you are misinterpreting my post about risk (Hong Kong shares are less risky) to something political that I had no intention of and no awareness of. I have visited Hong Kong numerous times, starting in 1991 so I think I am aware of the currency :wink: My point to the OP was, Hong Kong based shares (H shares) are better risk/reward to a western/US based investor for many reasons beyond just P/E. Yes of course P/E is much lower than A shares but that is just the surface. Beyond that the reasons are 1) Hong Kong currency is still different from Yuan/ renminbi 2) Due to the long British rule, its stock market is more like a western stock market than (at present) Shanghai or Shenzen 3) Due to the aforementioned rule of law, there aren't draconian rules about selling shares etc that exist for A shares. These things could all change of course over time as Hong Kong gets more integrated into mainland China..

As such, given the choice to hold the same company's shares as A shares or H shares, a western investor, at present should prefer the H shares.

Beyond that, no political commentary was intended. I love the sense of drive in Asia in general and Hong Kong reminds me of of New York in its pace. Why would I be disrespectful?

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Re: China's A, B and H Shares

Post by lack_ey » Tue Mar 01, 2016 4:19 pm

Hank Moody wrote:I actually researched it and found that their current holdings exclude A shares too. Their EM funds have a 15% allocation to China, and nearly all is traded on the HK exchange.
No, you didn't check closely enough. Several months ago, you would have been right, but as they announced last year (and more recently when they started pulling the trigger), they've been moving to add China A shares.
https://advisors.vanguard.com/VGApp/iip ... exFundChgs

Following the transition index specially cooked up for them:
http://www.ftse.com/Analytics/FactSheet ... e=VALIANT2

Compare to these:
http://www.ftse.com/Analytics/FactSheet ... ame=AWALLE
http://www.ftse.com/Analytics/FactSheet ... Name=GALLE

Note the China weighting and the number of constituents and compare to what Vanguard lists for its fund.

Also, the 15% is wrong. Even the old index has a lot more than that.

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Hank Moody
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Re: China's A, B and H Shares

Post by Hank Moody » Tue Mar 01, 2016 4:50 pm

My comment referred to DFA's EM exposure.
lack_ey wrote:
Hank Moody wrote:I actually researched it and found that their current holdings exclude A shares too. Their EM funds have a 15% allocation to China, and nearly all is traded on the HK exchange.
No, you didn't check closely enough. Several months ago, you would have been right, but as they announced last year (and more recently when they started pulling the trigger), they've been moving to add China A shares.
https://advisors.vanguard.com/VGApp/iip ... exFundChgs

Following the transition index specially cooked up for them:
http://www.ftse.com/Analytics/FactSheet ... e=VALIANT2

Compare to these:
http://www.ftse.com/Analytics/FactSheet ... ame=AWALLE
http://www.ftse.com/Analytics/FactSheet ... Name=GALLE

Note the China weighting and the number of constituents and compare to what Vanguard lists for its fund.

Also, the 15% is wrong. Even the old index has a lot more than that.
-HM

lack_ey
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Re: China's A, B and H Shares

Post by lack_ey » Tue Mar 01, 2016 5:28 pm

My bad, sorry. That makes a lot more sense.

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