SHANGHAI - Chinese stock investors are finally seeing value in domestic shares, but there's a twist: instead of wading back onto battered onshore exchanges, they've gone shopping for bargains in Hong Kong.
By doing so they are exploiting a long-standing market distortion that means the average share price of a dual-listed Chinese company is currently 40 per cent lower in Hong Kong than in Shanghai or Shenzhen.
The Hang Seng China Enterprises Index now trades at an average price-to-earnings (PE) ratio of slightly more than 6, much cheaper than broader Asian markets, which trade around 13, and the cheapest the HSCE has traded since December 2001.
The index of so-called H-shares is also trading below book value, meaning the average company's shares are pricing the business below its accounting value.
"Investing in Hong Kong stocks is the right choice, because the Hang Seng's current valuation is near historic lows; the kind of opportunity which has generated handsome returns previously," said Zhu Haifeng, a 31-year-old investor in Hubei province, in central China.
Zhu, who left his construction business to become a full-time stock investor, told Reuters he had boosted his Hong Kong equity exposure this year by roughly 70 per cent to more than 6 million yuan ($912,100), while slashing his exposure to onshore stocks.
His Hong Kong portfolio, focused on dividend-yielding shares in mainland companies such as China Shenhua Energy and Television Broadcasting Ltd, now accounts for roughly 65 per cent of his total equity exposure, he said.
Zhu is not alone. A number of measures show mainland money flowing into Hong Kong stocks, in part an unintended consequence of Beijing's extraordinary efforts to prop up its imploding domestic market.
The E Fund Hang Seng China Enterprises Index ETF for example, an onshore exchange-traded fund managed by a quota system tracking the HSCE, has seen huge inflows from Chinese investors this year.
Even as the HSCE has slumped roughly 15 per cent year-to-date, the ETFs' assets under management have jumped 15 per cent during the period, to 5.7 billion yuan.
And the number of fund units, which eliminates the effect of price fluctuations on fund value, has surged 37 per cent this year, to 6.8 billion units, making it the second-largest ETF in Shanghai by that measure.
Yang Jun, fund manager at E Fund Management Co Ltd, said that typically ETFs grow in assets when the market is rising, but that has not been the case with HSCE Index ETF so far this year. "Unit prices may be declining, but assets under management are growing rapidly," he said.
In another sign of change, the flow of money into Hong Kong from China via the Hong Kong-Shanghai Stock Connect pilot programme exceeded flows from Hong Kong into Shanghai last week for the first time since April.
The long-running price difference between Hong Kong and mainland exchanges reflects vastly different regulatory regimes - China's closed capital account means its markets are driven by sentiment among the domestic retail investors who dominate there, while open Hong Kong is more driven by international money managers and follows moves in global capital markets.
Fund managers had expected the gap to narrow or vanish with the launch of the Stock Connect in 2014, but it has persisted and even widened since then, with prices further distorted by a mainland rally that took off in late 2014 and burst in mid-2015.
The discount has been aggravated by Beijing's attempts to halt the massive onshore stock crash in August, in which a"national team" of investors poured money into sliding onshore markets to prop up key indexes.
Analysts say that put an artificial floor under the market when many company share prices were still extremely expensive compared with international peers.
For example, even after falling nearly 50 per cent from its summer peak, the average company listed on the ChiNext growth board in Shenzhen is still pricing at more than 60 times earnings, compared with around 20 for the Nasdaq 100 .
Some analysts argue that investor concern over tumbling onshore markets and China's slowing economy have also hurt shares in Chinese companies listed in offshore markets beyond Hong Kong.
The MSCI China Index, for example, which focuses on offshore listed Chinese firms, now enjoys a PE of around 10, much cheaper than the Wall Street benchmark S&P 500 index , which stands at 18.
Andy Rothman, investment strategist at Matthews Asia, argued that the time was ripe for a stock-picking approach towards China.
The Matthews Asia China portfolio, which is focused on quick-growth consumer plays, was still priced at a reasonable 13 times earnings, he added.
"While the overall market both in (domestic) A-shares, and to a lesser extent in Hong Kong can be expensive, there are plenty of individual stocks which are reasonably priced," he said.
Not everyone is convinced these low prices represent bargains, however, given the worldwide equities sell-off.
"It's true that valuation of Hong Kong shares is low, but they're exposed to global capital markets, where the general mood is 'risk-off'," said Yang Hai, analyst at Kaiyuan Securities.