Zhongjin: How much allocation space do foreign investors have?

The noteworthy changes in liquidity this week are: 1) EPFR data shows that as of Wednesday (February 19th), active foreign investors continue to withdraw from the Chinese market overall, but the outflow has narrowed in scale; at the same time, passive foreign investors are accelerating their inflows; 2) in terms of the Stock Connect, the daily average trading volume of northbound funds has increased compared to last week, and southbound funds have accelerated significantly, with a single-day inflow on Tuesday reaching a new high since January 2021; 3) global stocks are seeing inflows, while bonds and the currency market continue to see inflows; 4) US stocks are seeing inflows, while outflows from emerging markets have slowed. In terms of domestic liquidity, southbound funds are accelerating their inflows. This week, southbound funds saw a significant inflow of 51.21 billion Hong Kong dollars, more than double the inflow of 21.77 billion Hong Kong dollars last week. The previous week saw outflows in southbound funds, possibly due to some investors who bought in early October seeing positive returns. With the market continuing to rise, especially driven by Alibaba's financial report on Friday, southbound funds accelerated their inflow, with a significant inflow of 22.42 billion Hong Kong dollars on Tuesday alone, reaching a new high since January 2021, and a net outflow on Thursday indicating increased divergence, but with Alibaba's boost on Friday, southbound funds flowed in again with 14.04 billion Hong Kong dollars. Overall, southbound transactions accounted for 30% of the total trading volume on the Hong Kong Stock Exchange's main board, remaining at this level since rising from 20% in November last year. This week, southbound transactions accounted for 31% compared to last week, a slight increase of 2.3pp, with the value of southbound holdings on the Hong Kong Stock Exchange main board remaining at around 10%, without any significant increase. At the individual stock level, southbound funds were more concentrated in their buying this week, with more inflows into Alibaba, China Mobile Limited, Semiconductor Manufacturing International Corporation, and Kuaishou, and outflows from Tencent. Alibaba saw a significant inflow of 17.3 billion Hong Kong dollars this week, accounting for one-third of the total net inflow of southbound funds for the week, and Alibaba's southbound holdings increased from 5.2% last Friday to 5.8% this week. Foreign funds are generally following the previous trend, with active foreign funds continuing to flow out but in smaller amounts, while passive foreign funds are accelerating their inflows. As of Wednesday (February 19), in the Hong Kong stock market: 1) passive funds (ETFs) are accelerating their inflows, with passive foreign funds flowing into Hong Kong and ADRs increasing from 540 million US dollars last week to 910 million US dollars, mainly focused on investing in Chinese and Chinese concept stocks, in line with investors using these two index tools to hedge the technology market; 2) active funds (mainly Long-only) are seeing a narrowing outflow, with outflows mainly from funds focusing on China and emerging markets, and inflows mainly into Chinese concept funds. Therefore, although some trading venues have reported that some long-term funds have started flowing in, according to EPFR statistics, the overall net active foreign funds have not yet returned; 3) the short-selling ratio has decreased significantly from its peak of 19% on Tuesday to 13.7% on Friday, indicating potential short squeezes and hedging fund liquidations. In comparison, passive foreign funds inflows into A-shares remain steady compared to last week, at only 430 million US dollars, while active foreign funds continue to flow out. Foreign funds have how much allocation space? As of December 2024, the proportion of global active funds that can invest in Chinese stocks as a percentage of their asset size is 6.1%, lower than the benchmark index by 1.1 percentage points (i.e. under-allocated), which is still at a historical low level and significantly lower than the peak of 14.6% at the beginning of 2021. Assuming that foreign funds gradually become more optimistic and willing to increase their allocations, we estimate the following scenarios: 1) Scenario one: as global and Asian (excluding Japan) active funds are currently over-allocated to Asian countries like South Korea and India, if the allocation to these markets falls to five-year lows in the future, funds will reallocate to China, resulting in an inflow of 6.3 billion US dollars, close to the outflow since October 2024 (8.8 billion US dollars); 2) Scenario two: the current under-allocation of 1.1 percentage points is fully allocated back (as it was at the end of 2021), resulting in an inflow of 40.3 billion US dollars, equivalent to the total outflow from the Chinese market according to EPFR since the beginning of 2021 (approximately 41.9 billion US dollars). However, it is important to note that the return of active foreign funds is contingent on further realization of the AI industry trends and macro narratives to provide more catalysts. In addition, it is worth noting that on February 21, the Hang Seng series index announced the quarterly adjustment results. Due to restrictions on individual stock weights not exceeding 8% in the Hang Seng Index and the Hang Seng Technology Index, stocks with weights exceeding 8% in the index (such as Alibaba, Tencent, HSBC, Xiaomi, SMIC, etc.) due to recent price increases will have their weights "adjusted" passively on the execution date of the adjustment (March 7), leading to a passive "reduction" in weights. In terms of global liquidity, US stocks have seen inflows, while Japanese and Indian stocks have accelerated outflows. As of Wednesday (February 13th-19th), active foreign funds in the Indian market saw a slight increase in outflows to 510 million US dollars (compared to 430 million US dollars last week), while US stocks went from outflows of 40.87 million US dollars in the previous week to inflows of 1.45 billion US dollars.In January, Japan's stock market saw an accelerated outflow of $138 million (compared to an outflow of $72.61 million last week).Active foreign investment continued to flow out, while passive inflows accelerated; southward inflows accelerated Foreign funds: EPFR shows continued outflows of active foreign investment, but the scale has narrowed, and passive inflows have accelerated. As of this Wednesday (February 13th to 19th), active foreign investment in A-shares accelerated outflows by $130 million (compared to $80 million outflows last week), while passive funds inflows reached $430 million (similar to last week's $430 million inflows); at the same time, overall inflows of Hong Kong stocks and ADR foreign funds expanded to $680 million (compared to $280 million inflows last week), with active funds slightly slowing down from last week's $260 million outflows to $230 million outflows, and passive funds inflows accelerating significantly, almost doubling from $540 million inflows last week to $910 million inflows. Chart: Active foreign investment continued to flow out of the A-share market, but passive foreign funds saw a significant inflow Data source: EPFR, CICC Research Department Connectivity Fund: Northbound funds stopped disclosing net purchase amounts as of August 16, 2024, with daily trading volume increasing this week. This week, Northbound funds traded about 218.16 billion yuan, a slight increase from last week's 201.56 billion yuan in daily trading volume. In terms of individual stocks, BYD Company Limited, Contemporary Amperex Technology, NAURA Technology Group, and Kweichow Moutai had the largest trading scales. Chart: Weekly average daily trading volume of northbound funds Data source: Wind, CICC Research Department Southbound inflows significantly accelerated. This week, southbound funds flowed into Hong Kong dollars 51.21 billion, with a daily inflow of 10.24 billion Hong Kong dollars, doubling from the previous week's 4.35 billion Hong Kong dollars daily inflow. On Tuesday this week, southbound funds saw a single-day inflow of 22.42 billion Hong Kong dollars, reaching a new high since January 2021, but turned into a net outflow on Thursday. At the individual stock level, this week there was a significant inflow of Alibaba and China Mobile Limited, while outflows of Meituan and Tencent were observed. At the industry level, southbound funds increased holdings in consumer and mainland banks the most, while reducing holdings in energy, raw materials, and automotive sectors. Chart: Changes in southbound fund holdings this week Data source: Wind, CICC Research Department Global stocks turn into inflows, bonds and currency markets inflow; US stocks turn into inflows, outflows from emerging markets slow down Cross-market and asset allocation: US stocks turn into inflows, while developed Europe, Japan, and emerging markets continue to see outflows. In terms of active foreign investment, US stocks turn into inflows by $1.454 billion this week (compared to $0.041 billion outflows last week), developed Europe accelerates outflows by $1.319 billion (compared to $1.022 billion outflows last week), the Japanese stock market accelerates outflows by $0.138 billion (compared to $0.073 billion outflows last week), and outflows from emerging markets slow down to $1.305 billion (compared to $1.355 billion outflows last week). Across asset classes, global stocks turn into inflows, while bonds and currency markets continue to see inflows. Chart: Weekly net fund subscriptions for global stocks, bonds, and currency markets Data source: EPFR, CICC Research Department Allocation ratios: As of December 31, 2024, major types of global active funds had China allocations below the benchmark by about 1.1 percentage points, which is almost the same as the 1.2 percentage points underweight at the end of November. In terms of allocation ratios, global funds increased allocations to France (+0.23 percentage points) and Japan (+0.09 percentage points) the most, while reducing allocations to the US (-0.49 percentage points) and the UK (-0.10 percentage points) the most; in terms of extremely low allocations, in December France (+0.17 percentage points), Australia (+0.06 percentage points), and Germany (+0.04 percentage points) saw the most increases, while the US (-0.44 percentage points), the UK (-0.08 percentage points), and South Korea (-0.07 percentage points) saw the most decreases. In terms of regions, funds from Europe were the main force behind the outflows; at the sector level, foreign funds were overweight in Chinese healthcare, consumer, semiconductors and hardware, and capital goods, while underweight in internet, finance, and real estate. Chart: Allocation ratios for China and India decreased for active funds, while Japan's underweight ratio decreased slightly Data source: EPFR, CICC Research Department This article is reproduced from "Kevin Strategic Research," authored by Liu Gang, Wang Muyao, etc.; edited by GMTEight: Chen Xiaoyi.