Chinese Investors Invade Hong Kong With Link to Shanghai Exchange

NEW YORK (TheStreet) -- You might not have seen this in the news, but Hong Kong and China agreed to an historic hook up. The two have linked the Hong Kong and Shanghai stock exchanges for the first time.

That represents a huge investment opportunity -- albeit one that is under-appreciated, even unknown, here at home.

Now, foreigners who never before had access to China's main class of shares can trade them directly through Hong Kong, while Chinese investors who never before had access to Hong Kong shares can trade them through Shanghai.

This is huge.

And it's the reason why, a week before the announcement, I recommended that my newsletter subscribers prepare for this moment by buying the one Hong Kong stock that will clearly be the single-biggest winner as the agreement unfolds. Already those shares are up 8% in just a few days.

That growth will continue, and you can play the trend to a lesser degree here in the iShares MSCI Hong Kong ETF (EWH) .

Growing Demand for Hong Kong Shares

The agreement works on two levels. First, it allows foreign investors to trade Chinese shares. China has operated a bifurcated stock market through the Shanghai Stock Exchange for years. Only Chinese investors could buy so-called "A shares," while "B shares" were available only to foreigners. That created huge disparities between the share classes.

For one, there are far more -- and far-more interesting -- A shares than B shares. So, individual foreign investors who wanted to own some of the best companies in China were simply out of luck. Second, the Chinese typically view the stock market as a financial-oriented casino and routinely bid A shares up to ridiculous valuations. Meanwhile, Western investors have typically applied traditional financial analysis to the Chinese market and awarded B shares a valuation far less rich than the Chinese give the A shares.

That will now go away, creating unique hedging opportunities as the valuations between A and B shares narrows.

More interesting to me is what happens inside China.

Chinese investors have historically been locked into the Chinese yuan, the home currency, and they're eager to diversify their financial exposure to other currencies and other markets. Access to Hong Kong stocks is their first real opportunity to do that.

Play that out and it means the Hong Kong Stock Exchange is likely to see a surge in trading volume, particularly in the big, liquid blue-chip shares. My bet is that, along with playing in some of Hong Kong's small-cap names, the Chinese are going to want to own the biggest, safest investments they can find that are denominated in the Hong Kong dollar. That's the blue chips.

And that's the iShares MSCI Hong Kong ETF.

The Who's Who of Hong Kong

This particular ETF holds a basket of roughly 40 of Hong Kong's biggest companies. The top 10 is a who's who of Hong Kong corporate life: Hutchison Whampoa, a conglomerate that touches numerous sectors of the economy; Hang Seng Bank, one of the leading financial institutions in the city; and Cheung Kong Holdings, another conglomerate that itself owns a smorgasbord of top-listed Hong Kong stocks.

Moreover, Hong Kong's stock exchange is assuredly going to make hay with this new arrangement by creating new investment products for the Chinese market that provide various baskets of Hong Kong shares wrapped into ETF- and mutual fund-like investments. Thus, the Chinese money that flows into Hong Kong through Shanghai will pump up the volume for Hong Kong's blue chips.

That increasing volume will drive those share prices higher going into 2015 and beyond.

So, now is the time to get into Hong Kong, before the flood of Chinese money begins to pour in.

At the time of publication, the author held a position in a trading service in the Hong Kong Exchange.

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

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You can view the full analysis from the report here: MSFT Ratings Report

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