Why Foreign Investors Are Still Reluctant to Buy Chinese Stocks

TAIPEI, Taiwan (TheStreet) -- China's stock doctor is in but the prescriptions aren't helping the patient yet.

The investment-hungry country began allowing more than 500 of its listed companies to trade on the unrestricted market in Hong Kong this month to bring in foreign capital. But the program, called Shanghai Hong Kong Stock Connect, missed its quotas in the first week.

Then, on Friday, Beijing cut interest rates, the first time since mid-2012, to stimulate company performance. That move boosted share prices and could hold them up if more cuts follow.

Both rescue attempts have stirred global interest in China's A shares, which are enticingly cheap and allow trades in solid, on-the-move companies such as Ping An Insurance and smartphone heavyweight Huawei Technology.

But investment researchers warn that low prices rule because the country hasn't cured underlying ailments such as lack of transparency, patchy regulation and a perceived lack of value for minority shareholders. China remains a buyer-beware market, albeit an improving one.

"It's still a challenge finding companies there with good transparency and assurances on shareholder value alignment, though it has improved, looking back over the years," says Chou Chong, investment director with Aberdeen Asset Management Asia in Singapore.

Aberdeen will cautiously launch an A share investment fund because of client demand, and as a "starting point" to finding viable companies in China, adds Nicholas Yeo, the asset manager's China head of equities. "You have to pick the better apples from a bucket of bad ones," Yeo says.

Lack of transparency met murky regulation over shoddy public notification about when the Shanghai Hong Kong Stock Connect would begin.

"I suspect that the launch of the Connect scheme has been poorly managed with only one week's notice given and key rules on taxation not clarified until the last minute," says Mark Williams, chief Asia economist with Capital Economics in London. "Fund managers and investors need more time to come to an informed decision on whether to participate."

Consequently, the 254 foreign institutions with quotas to buy shares in China face the same risks now as ever. That could affect asset management giants such as BlackRock  (BLK) and Invesco  (IVZ) . BlackRock, the world's largest fund manager with $4.32 trillion in total assets under management, had China quotas of $520 million as of June. Fellow American fund manager Invesco is going in the same direction. Neither would comment.

Their Australian peer, AMP Ltd., expects markets to improve. A shares are up 18% this year after what AMP investment strategy head Shane Oliver calls a "long bear market" since 2009. He calculates a price to "historic earnings" ratio of 10:9 with prices lower now than five years ago. As a show of confidence, AMP has agreed to buy 20% of China's biggest pension firm, China Life Pension Co.

Cheap shares may ultimately offset doubts about regulation, transparency and bets for minority shareholders.

Some economists also expect last Friday's cuts in one-year lending and deposit rates to bring stronger corporate returns if more reductions follow, in turn raising prices. They already pushed shares to a three-year-high Monday, followed by nearly 1.4% gains Tuesday, the official Xinhua News Agency reported.

The Shanghai Hong Kong Stock Connect, which lets investors without licenses from Beijing trade shares of 568 mainland China-listed companies, may join the rate cuts in giving life to shares after the initial weak start. 

"To the extent that Shanghai-Hong Kong share market link helps boost foreign institutional participation in the Chinese A share market, it should act as a force to improve governance issues over time," AMP's Oliver says.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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