It is strange but true: Investors can buy shares of some of China's largest and most successful companies at a 25% discount.

Buying an asset at this price is a great deal for investors. It means that it is much easier to earn great returns.

Chinese companies listed on mainland China exchanges are known as A-shares. Mainland exchanges, such as Shanghai and Shenzhen, trade in Chinese yuan.

Local Chinese investors can buy and sell these shares, but foreigners can't, unless they have special permission from the Chinese government.

Some of these mainland-based companies can also list shares on the Hong Kong exchange. These shares are regulated by Chinese law but trade in Hong Kong dollars.

These are called H-shares. They trade like any other stock on the Hong Kong exchange, they are available to foreign investors, and they are one of the best ways to invest in China.

Image placeholder title

Large Chinese companies frequently have both A-share and H-share listings. A company like this has A-shares that are traded only on mainland China exchanges, and it has H-shares that are traded in Hong Kong.

These companies are good to watch because H-shares can often trade at a discount to A-shares.

The chart below shows the Hang Seng China AH Premium Index, which measures the spread between the A-shares and H-shares of the 63 largest dual-listed companies based in mainland China. Dual-listed stocks trade on both the Hong Kong Exchange and a mainland exchange.

As shown in the chart, in 2014 A-shares were trading at a slight discount to H-shares for dual-listed companies. But their premiums have widened and a large gap separates China and Hong Kong share valuations.

A-shares that trade on the mainland are valued 25% higher than their H-share counterparts that trade in Hong Kong.

Image placeholder title

No one can fully explain why H-shares trade at a discount to A-shares. But here are three possible contributing factors:

  • Different currencies and markets: Hong Kong's currency is pegged to the dollar, but mainland stocks are traded in Chinese yuan. Hong Kong and Chinese markets also have different regulations. These factors likely also play a role in A-share and H-share premiums.
  • Different investor base for A-shares and H-shares: Individual and retail mainland China investors dominate A-shares trading. These investors are known to be a little more emotional and can be volatile traders. But Hong Kong has a greater number of institutional investors that tend to focus on fundamentals and valuations.
  • Difficulties involved in cross-border trading: Monetary restrictions in China mean that money doesn't flow freely between Hong Kong and mainland exchanges. It is also hard for foreign investors to short stocks on mainland exchanges. Both these factors make it difficult to simultaneously buy and sell in these markets in order to take advantage of differing prices for the same asset, otherwise known as arbitrage. If this were easier, the difference between A-shares and H-shares would be smaller.

This discount is one of the great anomalies in global investing, but, it is important to note that shares of the same company often trade at lower valuations in Hong Kong than they do in Shanghai or Shenzhen.

As an investor, it pays to identify and exploit the discounted shares because these prices won't last forever.

---

There are a number of investment-worthy H-shares listed in Hong Kong. We just issued a report that can show you the best way to earn potentially big returns on these discounted shares. You can learn more by clicking here.

This article is commentary by an independent contributor. 

Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.