CITIC SEC: How have foreign investor behaviors changed since the policy shift?

CITIC SEC released a research report stating that since the clear shift in policy tone at the end of the third quarter last year, the overall sentiment of foreign capital has turned from excitement to relative rationality. By the end of 2024, overseas active management products are still relatively underweighted in Chinese equities. In 2025, the importance of the specific content and effects of policies for foreign capital will be higher than the overall scale and timing of policies, and related macro price indicators may receive more attention. CITIC SEC believes that in the first quarter, trading foreign capital may continue to revolve around the policy node of March, while the timing of inflows for allocation-type foreign capital may need to wait until the signals in the second and third quarters become more clear. Once the fundamentals improve, there is ample room for long-term foreign capital to return. Since the clear shift in policy tone at the end of the third quarter last year, the overall sentiment of foreign capital has turned from excitement to relative rationality. The rhythm during this period is roughly as follows: Phase 1: From the end of September last year to the first week of October, after the political bureau meeting in September 2024 clearly stated a positive shift in fiscal policy, foreign capital experienced a brief but noticeable inflow, which may have exceeded the inflow after the reversal of epidemic prevention policies in January 2023 in terms of intensity. From tracking data, offshore Chinese active funds had a net purchase rate of +0.91%/+0.52% in the two weeks of October 2 and October 9 last year, significantly higher than the purchase level during the rebound at the end of April last year, close to the weekly purchase rate in January 2023; offshore Chinese ETFs had net purchase rates of +13.70%/+18.08% in the two weeks of October 2 and October 9, the highest level since 2021, reaching 6-8 times the peak weekly purchase rate in January 2023. Considering that the weekly net inflow of northbound funds was about 40 billion yuan in January 2023, CITIC SEC estimates that the net purchase amount of foreign capital in the last week of September and the first week of October was about 100 billion yuan. From the feedback of overseas roadshows during this period, both allocation and trading institutions have generally reversed their relatively cautious attitude towards the domestic policy tone since the second quarter of 2023, with a high level of discussion on policy space and market rhythm. Especially, they were excited about the higher stimulus scale reported by some foreign media, but there was relatively less exploration at the time into the details of the policies. In terms of behavior, allocation institutions had a slower pace of adjustment until signals of improvement in fundamentals appeared, adopting a relatively conservative attitude towards whether to increase positions after the National Day holiday, while trading institutions had commonly engaged in long positions and increased positions before the holiday, with high expectations for the post-holiday market. Phase 2: From late October last year to early December, foreign capital gradually turned into net outflows. According to tracking data, the average weekly net purchase rate of offshore Chinese active funds was -0.45% from November 6 to December 11 last year, and the average weekly net purchase rate of offshore Chinese ETFs during the same period was -1.78%. By the end of Phase 2, active funds had largely sold off the positions accumulated in Phase 1, while passive ETFs still had about 2/3 of the positions left over from Phase 1. Feedback from overseas roadshows during this period indicated that as specific counter-cyclical policy measures were gradually introduced by relevant authorities, overseas institutions gradually shifted their focus from the overall scale of policies to discussions on specific measures and potential effects. They highly acknowledged the major initiative to optimize bonds and also paid attention to the policy direction that could stimulate domestic demand. Some allocation institutions believed that the market enthusiasm was slightly higher than the existing policy content and fundamental conditions, so they chose to cash out some profits. On the other hand, trading funds mostly followed the market trends. Based on this, CITIC SEC judges that foreign capital entering the A-share market after November tended to have a relatively trading-oriented nature. Phase 3: Since the end of December last year, the outflow of foreign capital has slowed down. According to tracking data, the average weekly net purchase rate of offshore Chinese active funds from December 18 to December 31 last year was -0.29%, and the average weekly net purchase rate of offshore Chinese ETFs during the same period was -0.18%. The overall outflow pressure in Phase 3 has eased compared to Phase 2. Feedback from overseas roadshows during this period indicated that foreign institutions agreed with the contents of the political bureau meeting in December last year and the Central Economic Work Conference, and they were more concerned about the details and implementation effects of incremental policies in 2025. As the Christmas holiday approached at the end of December, overall trading activity tended to be flat. In January this year, there was a rapid adjustment in the A-share market, and some institutions started to make small purchases again. In 2024, overseas active management products are still relatively underweighted in Chinese equities. According to the LESG database, CITIC SEC uses the position changes of active funds based in Europe and the United States with the MSCI AC Asia Index and MSCI EM Index as benchmarks for China (including A-shares) as a reference. For each index, the top 10 products by net assets are selected as samples, and the positions are averaged. 1) The position of active funds with the MSCI AC Asia benchmark has slightly increased by 1.9 percentage points compared to 2023. By the end of 2024, the average position of sample funds in mainland China was 16.7%, a slight increase of 1.9 percentage points from the historical low of 14.8% in 2023, but still 1.4 percentage points underweighted compared to the benchmark index. Since 2021, these funds have significantly increased their allocation to Japan, reaching a historical high of 40.3% in 2023, about 10 percentage points higher than the benchmark index. In 2024, the average position significantly decreased to 36.4% (still overallocated), with the reduced positions in Japan mainly shifting to mainland China (+1.9 percentage points) and Taiwan (+3.1 percentage points). 2) Active funds with the MSCI EM benchmark continued to reduce their positions by about 0.8 percentage points compared to 2023. By the end of 2024, the average position of sample funds in China was 16.9%, between the levels in 2017 and 2018. Currently, they are underweighted by 11 percentage points compared to the index benchmark, with a decline of about 12 percentage points from the historical high (2020). The decreases in position values in 2021-2023 were -5.3, -2.4, and -3.6 percentage points each year, with a marginal slowdown in the decline in 2024. Since 2020, the proportion of Indian equities in the holdings of these funds has increased from 12.2% to 2%.In 2024, 19.94%, has exceeded China for 2 consecutive years.In 2024, the proportion of northbound funds holding A-shares as a percentage of the total market capitalization continued to decline, with an estimated net outflow of around 20 billion yuan for the full year. According to data disclosed by the People's Bank of China, as of the third quarter of 2024, the proportion of overseas institutions and individuals holding stocks in A-shares as a percentage of the total market capitalization was approximately 4.11%, which is similar to the 4.13% in the fourth quarter of 2023. This indicates that overall foreign holdings were relatively stable before the policy shift. According to data from the Hong Kong Stock Exchange, in the third quarter of 2024, northbound funds held approximately 3.16%, corresponding to QFII holding about 0.95% during the same period. As the central bank has not yet released the overall foreign investment data for the fourth quarter of 2024, analysis of Hong Kong Stock Exchange data by CITIC Securities shows that northbound funds held approximately 2.86% in the fourth quarter of 2024, a decrease of about 0.3 percentage points from the third quarter of 2024, and a decrease of about 0.08 percentage points compared to the fourth quarter of 2023. This indicates that there may have been some reduction in foreign investment under the perspective of northbound funds in 2024, and CITIC Securities estimates that the net outflow for the year is approximately 20 billion yuan. Based on changes in the number of shares held and the average transaction price during the period, CITIC Securities' calculations show that after the policy shift, the main net inflow industry for northbound funds in the fourth quarter of 2024 was non-bank financial institutions, while the main net outflow industries included electricity and utilities, food and beverage, and medicine. In 2025, for foreign investors, the importance of the specific content and impact of policies will be higher than the overall scale and access, and relevant macro price indicators may receive more attention. According to feedback from foreign institutions that CITIC Securities has contacted, the rhythm of policy windows has been basically mastered, with a high level of attention still focused on the "two sessions" in March. Expectations for key policy indicators (deficit rate, growth rate targets, etc.) have gradually aligned with those of domestic institutions. Therefore, CITIC Securities believes that the importance of policy effectiveness for foreign investors will be higher starting from the second quarter of this year. In terms of specific observation and verification indicators, foreign institutions' discussions are concentrated on macro price signals, including but not limited to housing prices in major cities, inflation rates (CPI, PPI), and capacity utilization in certain industries, to measure the matching of domestic supply and demand and inflation changes. Based on this, CITIC Securities believes that transactional foreign investors in the first quarter may continue to focus on the policy game around the March node, while the timing for flow-in from positioning-type foreign investors may have to wait until the signals in the second and third quarters become clearer. Once the fundamentals improve, there is significant room for long-term foreign capital to return. Risk factors: - The redemption and subscription of overseas China funds may differ from the actual inflow of foreign funds; - Sample private equity sentiment indicators do not represent the actual fluctuations in the positions of all private equity institutions in the market; - The positioning of sample active funds does not represent the changes in positions of all offshore funds; - There may be a certain margin of error in estimating the net inflow of northbound funds based on the average quarterly transaction price; - Domestic policy intensity, implementation effect, and economic recovery may fall short of expectations.