SH-HK Connect: New regime, unprecedented opportunity · Short Selling TBC (no naked shorts) X Block...

September 11, 2014

China Strategy

SH-HK Connect: New regime,

unprecedented opportunity

Portfolio Strategy Research

The ‘new’ investment case for China for global/A-share investors

SH-HK Stock Connect: Redefining the Chinese equity market

The Connect scheme brings China A to the global arena and potentially

unleashes significant portfolio flows from China to HK. We provide a

framework for the new market landscape for global and A-share investors.

Global investors: China A is too important to ignore

1. The scheme creates a single ‘China’ market which ranks as the 2nd/3rd

largest globally by cap/turnover, and adds 855 US$1bn companies to the

investable universe. 2. China A will likely be included in global benchmarks

soon, based on Korea’s and Taiwan’s experience. 3. Global investors may

be able to trade China growth more efficiently in China A. Key micro

overlays for stock picking may revolve around scarcity value, GDP proxy,

high/stable yields, QFII ownership, and proper management incentive.

A-share investors: Diversification, undervalued growth in HK

The scheme allows Chinese households to diversify their inefficient asset

allocation: 72% in property, 6% in equities. Their investment behavior and

demand for diversification suggest they may focus on: (1) mid-cap growth

stocks, including select dual-listed H on possible re-rating; (2) HK blue

chips with global footprint; and (3) household brands not available in A.

Think ahead and get prepared

a) Future roadmap of the scheme; b) A-H valuation convergence; c) market

impact of liberalization; d) end game for B shares; e) competition between

SH and HK ; and f) business challenges for investors

This report is a modified version of SH-HK Connect: New regime,

unprecedented opportunity, originally published on Sep 1, 2014.

Kinger Lau, CFA +852-2978-1224 [email protected] Goldman Sachs (Asia) L.L.C.

Timothy Moe, CFA +852-2978-1328 [email protected] Goldman Sachs (Asia) L.L.C.

Ben Bei +852-2978-1220 [email protected] Goldman Sachs (Asia) L.L.C.

Chenjie Liu, Ph.D +86(10)6627-3324 [email protected] Beijing Gao Hua Securities Company Limited

Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investorsshould be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investorsshould consider this report as only a single factor in making their investment decision. For Reg AC certification and otherimportant disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed bynon-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.

The Goldman Sachs Group, Inc. Global Investment Research

September 11, 2014 China

Goldman Sachs Global Investment Research 2

Executive summary

A paradigm shift presents new opportunities The SH-HK Stock Connect Scheme will likely commence in October this year, based on

guidance from the exchanges when the scheme was first announced in April 2014. In this

report, we aim to look beyond the short-term flow and investment implications, and focus

on the structural opportunities and the new investment case for Chinese equities that

this policy breakthrough may offer global and A-share investors. For our analytical purpose,

we assume full liberalization of the scheme throughout this report unless otherwise stated.

Our analysis and conclusions are structured as follows:

Part 1: Global investors—China A will become too big to ignore

The scheme essentially integrates China A and HK, creates the 2nd/3rd largest equity

market globally by market cap/turnover, and opens up the largely internally-driven

China A shares to global investors. Close to US$4tn of incremental market cap and 855

companies (ex dual-listed) with above US$1bn of market cap will become accessible to

investors through HK (568 companies with US$2.4tn on current configuration).

We believe China A will soon be included in global equity benchmarks, expedited

by the scheme, and supported by the experiences from Korea and Taiwan during their

respective market opening process.

Global investors may be able to monetize China’s still promising growth in a more

efficient and less restrictive manner in A than has previously been the case.

Other appeals: (1) High and stable dividend yields, and (2) Positive portfolio effects.

Part 2: A-share investors—Diversification, underpriced growth in HK

Chinese household asset allocation is far from efficient: 72% in real estate, 6% in

equities—They are incentivized to diversify but channels are rather limited.

HK-listed stocks provide three themes of diversification: (1) Geographic (non-China

revenues); (2) Sector (scarcity value); and (3) Business (Chinese household brands).

A-share investors are biased towards growth and small caps—HK-listed stocks with

similar profile and relatively low valuations than in A could re-rate.

Part 3: Think ahead and get prepared

Future roadmap of the scheme: We see upside risk to both the scale and scope.

A-H P/E convergence: Potential re-rating on select H shares.

Market impact of liberalization: Potential near-term excitement, but not long-lasting.

End game for B shares: Likely more B-H conversion to take place.

Shanghai vs. HK: Not a zero-sum game as two-way flows could be significant.

Challenges: Revenue opportunities for investors will come with higher cost base.



Exhibit 1: What is the Shanghai-Hong Kong Stock Connect Scheme?

Source: HKEx, SSE, SAFE, CSRC, Goldman Sachs Securities Division, Goldman Sachs Global Investment Research.

Exhibit 2: Big picture: It is a part of the broader financial/capital market reform and liberalization process

Source: HKMA, PBOC, CSRC, SFC, SSE, Goldman Sachs Global Investment Research

Existing (R)QFII Quotas – ~RMB 601bn (~US$96.848bn)

New Stock Connect Quota – RMB 300bn (~US$48bn, 33% of total)

Existing QDII Quota – ~RMB 499bn (US$80.493bn)

New Stock Connect Quota – RMB 250bn (~US$40bn, 33% of total)

Northbound

Southbound

RMB 13bn (~US$2.1bn) daily quota (19% of SSE securities’ ADVT)RMB 300bn aggregated quota (~5% of SSE securities’ estimated float)

RMB 10.5bn daily quota (~US$1.7bn) 33% of SEHK securities’ ADVT) RMB 250bn aggregated quota (~3% of SEHK securities’ estimated float)

Northbound (to SSE) Southbound (to HKEx)

Eligible Investors No restrictions (local / foreign, retail / institutional accepted)Institutional investors (no restrictions on account balance); Retail investors with account balance > RMB 500,000

Investible World568 Eligible Names SSE 180 Index / 380 Index Dual-listed A & H shares listed SSE

266 Eligible Names Hang Seng Composite LargeCap & MidCap Indices Dual-listed A & H shares listed SSE

Market Hours Opening Call Auction (09:15 – 09:25) Morning Continuous Auction (09:30 – 11:30) Afternoon Continuous Auction (13:00 – 15:00)

Pre-opening Session (09:00 – 09:30) Morning Session (09:30 – 12:00) Afternoon Session (13:00 – 16:00)

Order Types Limit only (no amends, must cancel & re-enter) At Auction (Pre-opening) Enhanced Limit (Continuous Trading) No amends, must cancel & re-enter

Trading Currency RMB for trading & settlement HKD to trade, RMB to settle

Pre-trade Checks Broker level checks on Sells (based on T-1 holdings) Individual level checks on Buys (money) and Sells (stock)

Intra-day Trading X √

Margin Trading TBC (offshore) X

Securities Lending TBC (offshore) X

Short Selling TBC (no naked shorts) X

Block / Manual Trades X (block not allowed / manual not supported) X (block not supported / manual not allowed)

Odd Lots Sells only TBC Sells only (HKEx) / Both Buys and Sells (SSE)

Settlement Cycle T-day (stock), T+1 (money) T+2 (DVP)

Confirmed Fees & Taxes(New CCASS fee, Mainland Dividend & Capital Gains taxes TBD)

Handling Fee (SSE) Securities Mgmt. Fee (CSRC) Seller Stamp Duty (SAT) Clearing: Transfer Fee (ChinaClear)—Note par

value RMB1 per share ex 601899 & 603993

0.696 bps0.200 bps

10.000 bps6 bps on

par/face value

Trading Fee (HKEx) Transaction Levy (HKSFC) Buy/ Sell Stamp Duty (HKIRD) Clearing: Settlement Fee (CCASS)

0.500 bps0.300 bps

10.000 bpsHKD$2 - $100

Market Comparison

Connectivity Model

Apr 14Mar 13 Jun 13 Nov 13

Other liberalization

RMB liberalization

Equity market

QFII

announcedRQFII

expanded to

US$50bn

1. Settlement and

Clearing agreeement

on RMB business

between China and

Korea

2. PBOC abolished

pricing restrictions on

banks; FX

transactions with

corporates and

households

SH-HK Stock

Connect

Overnight RMB funds

on T+0 basis and one-

day funds on T+1 basis

provided for Authorized

Institutions

CNH HIBOR

fixing launched

Apr 04 Dec 05 Jun 07 Jul 09 Jul 10 Aug 11 Jul 12 Nov 12 Jan 13

Started Personal RMB

Business in HK

Expand HK personal

RMB Business

Settlement and Clearing agreement on RMB

business between PBOC and HKMA

RMB Trade Settlement

pilot scheme

Expand RMB Trade

Settlement Pilot

Scheme

RMB settlement expanded

to whole China

Announced pilot

scheme for RMB

settlement of QDII

Allow foreign

institutions to invest

in interbank bond

market with RMB

RMB bond issuance

in HK

First RMB-

denominated

REIT listed

RQFII announced

with initial quota at

US$20bn

Issued

guidance

on RMB FDI

Personal RMB

business expanded

to non-locals

RQFII to be expanded

to US$200bn

Qianhai

cross-

border yuan

loan

program

launched

Jul 14Apr 14Jun 13Mar 13

RQFII expanded to

financial institutions

registered and

with major operations

in HK.

Nov 02 Feb 04

Non-tradable

share reform

launched

SHFTZ was

set up

Providing

RMB 80bn and

RMB 80bn RQFII

quota to Korea

and Germany

respectively



Why the scheme is important to global investors

Exhibit 3: The combined A and HK market would be the 2nd largest equity market in the world and the 3rd largest by cash

turnover—simply too big to ignore

Source: World Federation of Exchanges, Bloomberg, Goldman Sachs Global Investment Research

Exhibit 4: China A is under-represented in the global equity universe but global investors may find more ‘GDP proxies’ in

the market (than in HK)...

Source: FactSet, MSCI, I/B/E/S, WFE, Wind, Goldman Sachs Global Investment Research.

Exhibit 5: ...especially when valuations are low and dividend yields are relatively high

Source: FactSet, MSCI, I/B/E/S, Goldman Sachs Global Investment Research

19.2

6.7 6.74.6

3.9

0

5

10

15

20

25

NY

SE

Ch

ina +

HK

NA

SD

AQ

Ja

pa

n E

xch

an

ge

SH

SE

+ S

ZS

E

Eu

ron

ext

Ho

ng

Ko

ng

SE

Sh

an

gh

ai

LS

E

Sh

en

zhe

n

Deu

tsch

e B

örs

e

Au

str

ali

a S

E

Ko

rea

Exch

an

ge

Taiw

an

SE

Sin

ga

po

re S

E

Total listed market cap (USD tn)

Note: Class market cap is used for

A share and H share

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

-

10

20

30

40

50

60

70

NY

SE

NA

SD

AQ

Ch

ina

+ H

K

SH

SE

+ S

ZS

E

Jap

an

Ex

ch

an

ge

Sh

en

zhen

Sh

an

gh

ai

Eu

ron

ex

t

De

uts

ch

e B

örs

e

Ho

ng

Ko

ng

SE

Ko

rea

Ex

ch

an

ge

Au

str

alia S

E

Ta

iwan

SE

LS

E

Sin

ga

po

re S

E

ADVT Annualized Turnover Velocity (RHS)2014 YTDUS bn

12.3%

10.5%

2.2% 1.8%

0.6%0.1%

0%

3%

6%

9%

12%

15%

GDP Total cap as %

of the world

MXCN % in AC

World

China

Underweight

in global MFs

A-shr wgt in

MXEM (IF=5%)

A-shr wgt in

AC World

(IF=5%)

MarketMacro

Pro forma weight

0.0 0.2 0.4 0.6 0.8

China-H

0.00.20.40.60.8

Autos

Banks

Beverage

Cap Goods

Cons Dur.

Cons Serv.

Diver. Fins

Energy

Health. Equip

Insurance

Materials

Media

Pharm Biotech

Real Estate

Retailing

Semi

Software

Stap Retailing

Tech H/W

Telecom

Transport.

Utilities

Average correlation of SPSg & EPSg to GDPg, past 10 years

0.0

China-A

0.0 0.2 0.4 0.6 0.8

Market

0.41

0.00.20.40.60.8

Market

0.55

-18%

-12%

-6%

0%

6%

12%

18%

8 7 6 5 4 3 2 1

Past (X)- years

Valuation chg f-12m EPS chg Price return

CAGR (%) MSCI China-A

6

10

14

18

22

26

30

34

38

f-P/E (X)

f-12m P/E (X) [RHS]

0

100

200

300

400

500

600

700

800

900

1,000

0

100

200

300

400

500

600

700

800

900

1,000

0% 1% 2% 3% 4% 5% 6% 7% 8% 9%

2014 Dividend Yield (%)

Cumulative free float cap, All China-AUS$bn US$bn

High-yield opportunities to

global Investors

AC World:

2.5%

165 companies,

Total free float cap = $244bn



Why the scheme is important to A-share investors

Exhibit 6: Chinese household balance sheets seem very skewed to real estate and cash equivalents

Note: OECD countries as of 2010; others as of 2000 except stated otherwise

Note: China and Taiwan as of 2012; Others as of 2013

Source: OECD, CEIC, Davies et al. (2009), Central banks of respective countries, Goldman Sachs Global Investment Research.

Exhibit 7: A-share investors are incentivized to diversify, and select HK stocks could help achieve that purpose

Source: FactSet, Bloomberg, MSCI, CEIC, Wind, Goldman Sachs Global Investment Research.

Exhibit 8: A-share retail investors prefer growth over value, small caps over large, and select underappreciated growth

opportunities in HK may appeal to them

Source: Bloomberg, FactSet, I/B/E/S, Worldscope, Wind, Goldman Sachs Global Investment Research.

Spain

Korea (2006)

New Zealand

Germany

Italy

Australia

NetherlandsJapan

Canada

USA

India

Indonesia SingaporeFrance

Taiwan

Japan (1990)

0

10

20

30

40

50

60

70

80

90

0 10,000 20,000 30,000 40,000 50,000 60,000

Per capita income (USD)

China

(2010)

Housing assets as % of total household balance sheets

7% 9% 10%17% 17%

21%

33%

2%5% 2%

3%2%

11%

11%

27%

56%

29%

59%

22%

31%

5%

0%

6%

9%

7%

3%

3%

7%

72%

54%

28%

45%

22%

42%

15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

CN JP UK KR AU TW US

Currency

Others

Other

Securities

Insurance &

Pension

Mutual Fund

Equity

Composition of household financial balance sheets

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 5% 10% 15% 20% 25% 30%

An

nu

ali

zed

to

tal

retu

rn (

%)

Annualized risk (%)

Deposit

Government bonds

Corporate bonds

Efficient frontier (China), past 10 years

Properties

Equities

(China-A)

Equities

(AC World)

After adding international

equities to the portfolio

Before

Optimal

combination

Before After

Govt. Bond -68% -50%

Corp. Bond 141% 119%

Properties 18% 16%

A-Shares 8% 4%

World Equities NA 11%

Optimal combination

0%

20%

40%

60%

80%

100%

95% 94%

63%

89% 88%

56%

0%

20%

40%

60%

80%

100%

MSCI China A MSCI China H MSCI Hong Kong

+ HSBC, SCB

By mkt cap

By revenue

2013 revenue exposure to China/HK(%)

12%

37%44%

5% 11% 6%

Exposure to

non- China/HK

0

10

20

30

40

50

60

70

80

90

100

0 5 10 15 20 25 30 35 40 45

15

E E

PS

g (

%)

Market Cap (USD bn)

Retail Ownership in the bottom 25%ile

Retail Ownership between 25%ile and 50%ile


Retail Ownership in the top 25%ile

0.5

1.0

1.5

2.0

2.5

Ja

n-1

1

Ap

r-1

1

Ju

l-1

1

Oct-

11

Ja

n-1

2

Ap

r-1

2

Ju

l-1

2

Oct-

12

Ja

n-1

3

Ap

r-1

3

Ju

l-1

3

Oct-

13

Ja

n-1

4

Ap

r-1

4

Ju

l-1

4

PEG (X)

Chinext

"New China"

GSNEWCHN

*PEG= trailing PE/ forward12m EPSg



Part 1: The case for Chinese (A-share) equities for global investors

Value proposition #1: Too big to ignore

The Stock Connect scheme essentially integrates China A and the HK market, creates

the world’s 2nd largest equity market by market cap (US$6.7tn) and the 3rd largest in

terms of cash trading (US$35.7bn/day). Turnover velocity of the combined market

would rank 2nd highest globally, just behind Nasdaq.

The scheme may add close to US$4tn of incremental market cap, and 855

companies with over US$1bn of listed market cap to the investable universe

assuming full liberalization (i.e. global investors can buy all A shares listed in both

Shanghai and Shenzhen).

The new investable universe represents 6.4% and 28.9% of the current MXAPJ market

cap on partial (only 568 stocks listed on SHSE) and full liberalization based on free-float

market cap. We only count A shares that are not listed in HK and A shares that are

priced at a discount to their H-share counterparts in the partial universe.

Exhibit 9: The combined A and HK market could be the

2nd largest equity market in the world (by exchange)...

Exhibit 10: ...and 3rd largest in terms of cash turnover

Source: World Federation of Exchanges, Bloomberg, Goldman Sachs Global Investment Research

Exhibit 11: The scheme may add close to US$4tn of

incremental market cap to the investable universe

assuming full liberalization

Exhibit 12: ...and 1,253 (1,171 ex dual-listed) companies

with over US$1bn of listed market cap

Source: CEIC, Goldman Sachs Global Investment Research.

19.2

6.7 6.74.6

3.9

0

5

10

15

20

25

NY

SE

Ch

ina +

HK

NA

SD

AQ

Ja

pa

n E

xch

an

ge

SH

SE

+ S

ZS

E

Eu

ron

ext

Ho

ng

Ko

ng

SE

Sh

an

gh

ai

LS

E

Sh

en

zhe

n

Deu

tsch

e B

örs

e

Au

str

ali

a S

E

Ko

rea

Exch

an

ge

Taiw

an

SE

Sin

ga

po

re S

E

Total listed market cap (USD tn)

Note: Class market cap is used for

A share and H share

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

-

10

20

30

40

50

60

70

NY

SE

NA

SD

AQ

Ch

ina

+ H

K

SH

SE

+ S

ZS

E

Jap

an

Ex

ch

an

ge

Sh

en

zhen

Sh

an

gh

ai

Eu

ron

ex

t

De

uts

ch

e B

örs

e

Ho

ng

Ko

ng

SE

Ko

rea

Ex

ch

an

ge

Au

str

alia S

E

Ta

iwan

SE

LS

E

Sin

ga

po

re S

E

ADVT Annualized Turnover Velocity (RHS)2014 YTDUS bn

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

China

HK shares

with no A-

share listing

Market cap (USD bn)

A shares

with no HK

listing

A shares

with H

shares

listing,

discount to

H-shares

A shares with H shares

listing, premium to H shares

Hong Kong

HK shares with A-

share listing with

value premium to

A shares

New

universe to

global

investors

(Total: 2416)

HK shares

with H-share

listing,

discount to A

shares

New

universe to

A-share

investors

(Total:

1733)

3,681

1,253

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

NA

SD

AQ

OM

X

HK

+ S

H +

SZ

To

ky

o S

E

LS

E

SH

SE

+ S

ZS

E

NY

SE

Au

str

alian

SE

Ko

rea E

xch

an

ge

De

uts

ch

e B

örs

e

Eu

ron

ext

Ta

iwan

SE

Sh

en

zhen

SE

A

Ho

ng

Ko

ng

SE

Sh

an

gh

ai

SE

A

Sin

gap

ore

SE

# of companies # of companies (Mkt cap >US$1bn)



Value proposition #2: China A will be added to global indexes soon

MSCI announced in June 2014 that China A will not be included in the MSCI EM index

for its upcoming index rebalancing largely due to the investability constraints linked

to the QFII/ RQFII quota systems. However, China A will remain on the review list as

part of the 2015 review process, results of which are to be revealed in June 2015.

FTSE announced in June 2014 the launch of the FTSE Global R/QFII Index Series to

prepare market participants for the inclusion of China A in FTSE’s standard indices

as a separate index. The next review is due in September 2014.

While China A isn’t in major global benchmarks yet, we believe the conditions for it

to be included are already in place because:

China has further liberalized the A-share market by raising the size of QFII

and RQFII, and broadening the scope of these programs geographically.

Although the Stock Connect is still subject to quota restrictions, it significantly

improves the accessibility of China A to foreign investors, with the total

Northbound quota representing close to 5%/20% of the existing free-float

market cap/daily turnover of the Shanghai Stock Exchange.

Based on the past experiences from Korea and Taiwan during their capital

market opening processes, it seems China A is not far from being included in

terms of the progress made on financial market liberalization, in our view.

We think the potential inclusion of China A in global equity benchmarks may catalyze a

catchup of allocations to China by global investors as it is currently under-represented

in the global equity market universe relative to its economic influence: China is

12.3% of global GDP, 11.3% of global trade, 23.1% of global FAI, and 7.9% of global

consumption but China’s weight in MSCI AC World is only 2.2%. Furthermore,

investors are generally underweight Chinese equities, as suggested by our

positioning analysis (in the offshore market) and the low QFII ownership of 3.0% in the

A-share market. If China A were to be included in MSCI global benchmark in the next

review, we estimate it could result in US$5.3bn/US$21bn of passive fund buying in

2016 assuming a 5%/20% inclusion factor (IF).

Exhibit 13: Korea’s and Taiwan’s experience suggests the conditions for A-share inclusion to global indexes are in place

Source: MSCI, Local stock exchanges, Goldman Sachs Global Investment Research

Event timeline

MSCI EM inclusion

Financial market liberalization

19

93

20

05

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

19

88

19

89

19

90

19

91

19

92

20

12

20

13

20

14

20

06

20

07

20

08

20

09

20

10

20

11

FI could invest via

foreign custodian bank

Korea

Partial opening of

the domestic stock

market to FIAllow FI to issue fixed

income securities

Allow foreign

enterprises

listing in KSE

First time

inclusion in MSCI

EM (20%)

MSCI EM

inclusion to 50%

Full inclusion in MSCI EM

China

QFII

launched

Personal

RMB

business

expanded

to non-

locals

Qianhai cross-

border yuan loan

program started Started personal

RMB business in

HK

Allow FI to participate

in interbank bond

market with RMB

Issued

guidance on

RMB FDI

RQFII

launched RMB bond

issuance in HK

SH-HK

Stock

Connect

First time inclusion

in MSCI EM (50%)Full inclusion in MSCI EM

FI can invest in local stocks

through ADR and trusts listed

in NYSE

QFII

launched

Expand

quota for 3m

money

market

instrument

Allow free capital

outward remittance

Allow

investment in

3m money

market

instrument

Open

future

market to

foreign

investors

QFII quota

limitation

cancelled

FI can buy

convertible

and financial

securities

Taiwan

(3)(1) (2)

(1) Before first-time QFII/ equity market opening

(2) After QFII, but before MSCI EM inclusion

(3) After first-time inclusion in MSCI EM

QDII quota

expansion

QDII

launched

FI limits on private/

state-run enterprises

raised to 55%/30%;

A number of

restrictions on FI

activities were lifted.



Exhibit 14: Chinese equities are under-presented in the equity space and the current foreign ownership is low

Source: Bloomberg, MSCI, Exchanges, CEIC, Goldman Sachs Global Investment Research.

Value proposition #3: More opportunities to monetize China growth

Chinese equities haven’t been an efficient vehicle for investors to trade China’s

strong GDP growth in the past decade: HSCEI and CSI300 have generated 15% and

10% total return CAGR since 2003, trailing the nominal GDP (US$) CAGR of 18% and

underperforming global peers in terms of converting economic growth into equity

returns.

The slippages between delivered equity returns and economic growth have been

mainly driven by the volatility of valuation changes while corporate revenue and

earnings have tracked macro growth reasonably well in A shares (Exhibits 16 and 17)

Looking ahead, we think the efficiency of equity tracking economic growth may

improve because:

Valuations are already at historically and cyclically low levels, measured

by both P/E and P/B, thereby reducing valuation volatility, at least to the

downside, in our view.

The opening up of the A-share market may allow investors to capture China

growth in a more efficient manner as the fundamentals (sales and earnings

growth) of many A-share sectors seem more sensitive to economic

growth than China stocks listed in HK, and these sectors tend to have

better depth (market cap, liquidity) and breadth (number of companies)

relative to the HK market.

Investors have the opportunity to invest in ‘scarce’ sectors which are only

available in the onshore market. Importantly, these sectors usually operate in

niche markets where the sensitivity to policy swings and cyclical volatility

tends to be lower than the traditional cyclical, FAI-related sectors, which make

up a significant portion of the offshore equity universe.

12.3%11.3%

7.9%

10.5%

2.2% 1.8%

10.2%

0.6%1.3%

0.1%

3.0%

0%

3%

6%

9%

12%

15%

GDP Total trade Consumption Total cap as

% of the

world

MXCN % in

AC World

China

Underweight

in global MFs

A-shr wgt in

MXEM

(IF=100%)

A-shr wgt in

MXEM

(IF=5%)

A-shr wgt in

AC World

(IF=100%)

A-shr wgt in

AC World

(IF=5%)

QFII (granted)

as % of float

cap in A

Market

China as % of the world

MacroPro forma weight



Exhibit 15: Equity returns have trailed economic growth in China in the past decade

Source: FactSet, MSCI, CEIC, Goldman Sachs Global Investment Research.

Exhibit 16: Earnings growth has been tracking GDP

growth quite well but not for stock returns

Exhibit 17: High base and valuation volatility has been a

key culprit for the lackluster headline index returns

Source: FactSet, MSCI, CEIC, Goldman Sachs Global Investment Research.

Source: FactSet, MSCI, Goldman Sachs Global Investment Research.

Exhibit 18: Valuations (ex- and cum- banks) are at historically and cyclically low levels, suggesting lower downside

valuation risks than in the past

Source: FactSet, Goldman Sachs Global Investment Research.

AUCN-A

CN-H

FR

DEHK

IN

ID

MY

PH

RU

SGSA

KR

TW

TH

TR

UK US

5%

10%

15%

20%

25%

0% 5% 10% 15% 20%

MS

CI T

ota

l R

etu

rn (

US

$)

Nominal GDP Growth (US$)

10-year CAGR (2003 - 2013)

ex-CN, RU

R² = 0.71

R² = 0.35

-0.75

-0.50

-0.25

0.00

0.25

0.50

0.75

1.00

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EPS growth vs. Real GDP growth

Total return vs. Real GDP growth

Rolling 5-year correlation MSCI China-A

-18%

-12%

-6%

0%

6%

12%

18%

8 7 6 5 4 3 2 1

Past (X)- years

Valuation chg f-12m EPS chg Price return

CAGR (%) MSCI China-A

6

10

14

18

22

26

30

34

38

f-P/E (X)

f-12m P/E (X) [RHS]

-

5

10

15

20

25

30

35

40

45

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

CSI300

CSI300 (ex-bank)

Average

+1 Stdev: 21.7X

-1 Stdev: 8.5X

Average: 15.1X11.7X

Z Score: -0.79

8.6X

Z Score: -0.99

Forward 12m P/E (X)

-

1

2

3

4

5

6

7

8

9

10

11

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

CSI300

CSI300 (ex-bank)

Average

+1 Stdev: 5.0X

-1 Stdev: 1.2X

Average: 3.1X1.9X

Z Score: -0.78

1.7X, Z Score: -0.72

Trailing 12m P/B (X)



Exhibit 19: Global investors may find more opportunities to monetize China growth in

select A-share sectors

Source: FactSet, MSCI, I/B/E/S, Goldman Sachs Global Investment Research.

Exhibit 20: Investors can find specific niche market exposures that are only available in A shares

Source: Wind, FactSet, Goldman Sachs Global Investment Research

0.0 0.2 0.4 0.6 0.8

China-H

0.00.20.40.60.8

Autos

Banks

Beverage

Cap Goods

Cons Dur.

Cons Serv.

Diver. Fins

Energy

Health. Equip

Insurance

Materials

Media

Pharm Biotech

Real Estate

Retailing

Semi

Software

Stap Retailing

Tech H/W

Telecom

Transport.

Utilities

Avg correlation [Top]

Average correlation/T-stats of SPSg & EPSg to GDPg, past 10 years

0.0

China-A

0.0 1.0 2.0 3.0

Avg T-stats (simple reg.) [Bottom]

Market

0.41

0.01.02.03.0

Market

0.55

GICS Sub-industry A HK

Cable & Satellite √ X 7 3,288 548 109 18

Commercial Printing √ X 7 2,599 371 116 17

Distillers & Vintners √ X 20 21,787 1,147 345 17

Drug Retail √ X 4 1,291 430 67 17

Electric Utilities √ X 14 4,669 334 80 6

Forest Products √ X 11 3,351 335 124 12

General Merchandise Stores √ X 10 3,487 349 79 8

Housewares & Specialties √ X 9 3,405 486 43 6

Motorcycle Manufacturers √ X 4 1,065 266 42 10

Multi-Utilities √ X 3 1,250 417 29 10

Office Services & Supplies √ X 3 1,233 411 16 5

Precious Metals & Minerals √ X 3 1,160 387 38 13

Publishing √ X 13 7,140 649 237 22

Research & Consulting Services √ X 5 5,089 1,018 66 13

Systems Software √ X 12 5,263 658 211 19

Trucking √ X 11 3,897 354 118 11

Average

company

ADVT

(US$ mn)

Industry

availability# of

companies

Total

freefloat

market

cap

(US$ mn)

Average

Freefloat

market

cap

(US$ mn)

Total

industry

ADVT

(US$ mn)



Value proposition #4: Relatively high yields – compelling with

global mandate

Our economists expect global rates (DM in particular) to stay at low absolute levels

in the foreseeable future although the Fed may begin to normalize its zero-interest-rate

policy starting 3Q15.

Markets with high dividend yields, and stable dividend growth and payout profile will

continue to be in demand in a low rates environment, in our view. China A is

currently yielding in a range of 2.9% to 4.2% depending on benchmarks,

meaningfully higher than the global aggregate of 2.5%.

Dividends of China A have also been growing very steadily with low volatility,

partly supported by the solid fundamental growth, and partly buttressed by the

government’s policy of encouraging dividends in the SOE sector.

Importantly, the high-yield opportunities seem concentrated in the large-cap, liquid

space which may attract interest from global investors with high-yield/income

mandates. We estimate the AUM of this subset is about US$1.3tn, of which 30% is

eligible to invest in A shares given their geographic focus.

Exhibit 21: China A is offering high dividend yields

compared with global alternatives...

Exhibit 22: ...with a relatively stable dividend profile



Exhibit 23: Over US$200bn free-float market cap of high-

yield opportunities

Exhibit 24: We estimate at least US$40bn of global and

Asia high yield/income funds will be looking to buy high

yield stocks in A shares

Source: FactSet, I/B/E/S, Goldman Sachs Global Investment Research.

Source: Bloomberg, Goldman Sachs Global Investment Research.

10

20

30

40

50

60

70

80

1

2

3

4

5

HS

CE

I

SH

CO

MP

Ch

ina

-H

CS

I 30

0

Ch

ina

-A

Au

str

ali

a

UK

Bra

zil

Sin

ga

po

re

Fra

nce

Ho

ng

Ko

ng

Th

ail

an

d

SA

Taiw

an

Ge

rma

ny

Can

ad

a

Ind

on

esia

Ja

pa

n

US

A

Ind

ia

Me

xic

o

Ko

rea

2014E D/Y (%) PayoutRatio (%)D/Y (%) Payout Ratio (%)

China Rest of the world

AC World,

2.5%

5%

10%

15%

20%

25%

30%

TW KR TH MX SA BR ID DE JP FR CA SG US AU CH UK HK IN

DPSg volatility, past 10 years

80

100

120

140

160

180

200

220A

ug

-06

Feb

-07

Au

g-0

7

Feb

-08

Au

g-0

8

Feb

-09

Au

g-0

9

Feb

-10

Au

g-1

0

Feb

-11

Au

g-1

1

Feb

-12

Au

g-1

2

Feb

-13

Au

g-1

3

Feb

-14

Au

g-1

4

Rebased trailing DPS integer, China-A

0

100

200

300

400

500

600

700

800

900

1,000

0

100

200

300

400

500

600

700

800

900

1,000

0% 1% 2% 3% 4% 5% 6% 7% 8% 9%2014 Dividend Yield (%)

Cumulative free float cap, All China-AUS$bn US$bn

High-yield opportunities to

global Investors

AC World:

2.5%

165 companies,

Total free float cap = $244bn Growth

20%

Yield/Income

10%

Value

16%Others

1%

Blend

53%

Global equity funds breakdown by style (incl. ETF)

Total AUM size = US$13.1tn, based on the Bloomberg fund universe

Europe

20%

APxJ

4%

Japan

1%

LATAM

0%

EEMEA

0%US

49%

Global

26%

Geographical Focus



Value proposition #5: Positive portfolio effects

It is well documented that China A’s return correlation with global equities has

been low as foreign investors’ access has been strictly regulated (by the QFII and

RQFII programs) and the market (trading activity) is largely dominated by onshore

individual investors who tend to embrace different investment objectives and styles

than institutional investors globally.

This unique characteristic of China A means adding it to a typical global, EM, or Asia-

focused portfolio, in most cases would likely generate positive portfolio effects, and

improve the theoretical efficient frontier in different phases of the business cycle. See

Appendix for details.

However, we reckon that as foreign participation and ownership increase, the

benefits of diversification may recede over time as foreign liquidity flows and

positioning become more important to market returns. See Part 3 for more analysis on

this topic.

Exhibit 25: A shares have exhibited low return correlations with major global markets,

given the low foreign investor participation and ownership


Exhibit 26: Adding China A to an EM portfolio could

provide positive portfolio effects... Efficient frontier, MSCI China A vs. MSCI EM, past 10 years

Exhibit 27: ...similar to adding to a global equity portfolioEfficient frontier, MSCI China vs. MSCI ACWI, past 10 years



CN-A CN-H APJ AeJ JP US EU EM WD Avg

CN-A 25% 34% 36% 20% 10% 15% 30% 17% 23%

CN-H 25% 92% 82% 64% 75% 85% 86% 88% 74%

APJ 34% 92% 98% 66% 73% 82% 96% 87% 78%

AeJ 36% 82% 98% 63% 67% 76% 95% 81% 75%

JP 20% 64% 66% 63% 54% 60% 61% 66% 57%

US 10% 75% 73% 67% 54% 85% 76% 95% 67%

EU 15% 85% 82% 76% 60% 85% 85% 96% 73%

EM 30% 86% 96% 95% 61% 76% 85% 89% 77%

WD 17% 88% 87% 81% 66% 95% 96% 89% 77%

Weekly MSCI market return (USD) correlation, past 10 years

12.0%

12.5%

13.0%

13.5%

14.0%

20% 25% 30% 35%

China-A

MSCI EM

An

nu

alize

dto

tal re

turn

(U

SD

)

Annualized return volatility

Optimal

CML

4%

6%

8%

10%

12%

14%

16%

10% 15% 20% 25% 30% 35%

China-A

MSCI ACWI

An

nu

alize

dto

tal re

turn

(U

SD

)

Annualized return volatility

Optimal

CML



Part 2: The case for HK-listed equities for A-share investors

Current state: A-share investors need to diversify

Chinese households’ balance sheets are heavily skewed towards real assets and

cash equivalents, with properties accounting for 72% of their total assets (financial

assets + real assets) and cash equivalents representing 72% of their financial balance

sheets. Equities, including both direct investment and indirect exposures through

mutual funds and retirement money, only take up less than 20% of their financial

holdings (6% of their total assets), significantly lower than the average of around

60% in more developed economies.

As such, this creates a situation where the theoretical investment frontier for

onshore investors is far from optimal. We believe a combination of factors is

responsible for this, including:

Limited investment channels (capital account regulations);

Specific local investment preference (property-heavy); and,

Inefficient interest rate setting mechanism (non-market-based, implicit

guarantee of SOE debts).

In the current setup, we estimate the optimal allocation for A-share investors is to

heavily overweigh corporate bonds (mainly due to moral hazard inefficiency), funded

by government bonds (unattractive risk/reward relative to corporate bonds), with

properties and onshore equities combining to around a quarter of the portfolio (Exhibit

29).

Assuming no drastic changes to the capital account and interest rate profile in the near

future, our model suggests adding global equities to the portfolio would enhance

the portfolio’s risk/reward tradeoff, with global equities taking shares from all

domestic asset classes.

Indeed, we note that the demand for diversification (or ‘going out’) from Chinese

investors (and consumers) has been strong, as evidenced by the rapid rise of

outbound FDI, overseas real asset (property) investment, and outbound consumption,

although outward equity portfolio flows have been subdued, constrained mainly by the

lack of investment channels.

Exhibit 28: Chinese household balance sheets seem very skewed to real assets and cash equivalents

Note: OECD countries as of 2010; others as of 2000 except stated otherwise

Note: China and Taiwan as of 2012; Others as of 2013

Source: OECD, CEIC, Davies et al. (2009), Central banks of respective countries, Goldman Sachs Global Investment Research.

Spain

Korea (2006)

New Zealand

Germany

Italy

Australia

NetherlandsJapan

Canada

USA

India

Indonesia SingaporeFrance

Taiwan

Japan (1990)

0

10

20

30

40

50

60

70

80

90

0 10,000 20,000 30,000 40,000 50,000 60,000

Per capita income (USD)

China

(2010)

Housing assets as % of total household balance sheets

7% 9% 10%17% 17%

21%

33%

2%5% 2%

3%2%

11%

11%

27%

56%

29%

59%

22%

31%

5%

0%

6%

9%

7%

3%

3%

7%

72%

54%

28%

45%

22%

42%

15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

CN JP UK KR AU TW US

Currency

Others

Other

Securities

Insurance &

Pension

Mutual Fund

Equity

Composition of household financial balance sheets



Exhibit 29: Adding international equities to a typical onshore investor’s portfolio could

improve the risk/reward tradeoff

Note (1): We use 1-year time deposit rate, S&P China Govt. Bond Index, S&P China Corp. Bond Index, and average building selling price (+ rental yield) to proxy returns for deposit, government bonds, corporate bonds, and properties respectively. Note (2): Annualized total return is the 10-year CAGR (Loc) for different asset classes; Risk is the annualized standard deviation of monthly returns.

Note (3): The mean-variance efficient frontier (MVEF) is constructed based on the assumption that investors’ goal is to maximize the expected return on their portfolio for a given level of risk taken (i.e. maximizing the mean for a given variance). For every level of expected return, there is a set of portfolio weights that minimizes the return volatility, and thus MVEF is constructed by different sets of optimal portfolio. Note (4): Optimal combination is calculated based on a hypothetical multi-asset-class portfolio that maximizes the Sharp ratio with risk-free rate being assumed to be the 1-year time deposit rate. Investors with different risk appetites are expected to hold different optimal portfolios lying on the MVEF that offers the best possible expected return at a given risk level.

Source: FactSet, Bloomberg, Wind, CEIC, Goldman Sachs Global Investment Research.

Exhibit 30: Demand for ‘going out’ is strong...

Exhibit 31: ...but portfolio flows (both in and out) are

constrained by the capital account regulations

Note: Outbound FDI is from Bloomberg, Total Chinese spending overseas is from World Tourism Organization, Real Estate investment overseas is from Jones Lang Lasalle.

Source: Bloomberg, World Tourism Organization, Jones Lang Lasalle, Goldman Sachs Global Investment Research

Source: Bloomberg, CEIC, Goldman Sachs Global Investment Research

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 5% 10% 15% 20% 25% 30%

An

nu

ali

zed

to

tal

retu

rn (

%)

Annualized risk (%)

Deposit

Government bonds

Corporate bonds

Efficient frontier (China), past 10 years

Properties

Equities

(China-A)

Equities

(AC World)

After adding international

equities to the portfolio

Before

Optimal

combination

Before After

Govt. Bond -68% -50%

Corp. Bond 141% 119%

Properties 18% 16%

A-Shares 8% 4%

World Equities NA 11%

Optimal combination

0

20

40

60

80

100

120

140

Outbound FDI Total Chinese

spending

overseas

Portfolio

outflows

2012

2013

US $bn

0

2

4

6

8

10

12

Real estate

investment

overseas

US $bn

+193%

+27% +45%

-46%

2%3%

39%35%

21%38%

11% 16%0%

50%

100%

150%

200%

Outward Inward Outward Inward Outward Inward Outward Inward

China (YE13) US (YE13) EU (YE12) Japan (YE12)

Direct Investment Portfolio Investment: equity

Portfolio Investment: debt Financial derivatives

Other investment Reserves

as % of

country GDP



Value proposition #1: Three themes of diversification in HK

We see HK’s diversification appeal for A-share investors coming from 3 different angles:

Revenue diversification: A-share companies’ revenues, and to a large extent H-share

companies, are China-centric, with China A and H generating less than 10% of their

total revenues from non HK/China regions.

In HK, using the MSCI HK index as a proxy, HK companies generated over 30% of their

sales overseas, with a number of the largest listed companies in HK (excluding A-H

dual-listings) boasting significant business footprints in non HK/China regions.

Looking ahead, the well-developed capital market infrastructure, efficient market

access, and enhanced integration with China (HK’s hinterland) should continue to help

attract multinational and emerging companies to list their shares in HK, further

reinforcing HK’s status as the financial gateway of liquidity flows in and out of China.

Sector diversification: Similar to the argument for global investors who look to

broaden their investment frontier in the A-share market, we believe A-share investors

would embrace a similar mentality when they position in the HK market. Upstream

oil/gas producers, Macau gaming, and property/casualty insurance are the three major

sectors that are available only in HK and not in China A, based on GICS sub-industry

classification (level 4).

Business diversification: A-share investors (and press) often bemoan the fact that

some of the Chinese household brand names are not listed domestically and hence

they are unable to monetize the growth opportunities that these companies may offer.

Based on Interbrand’s ranking, we note that 12 out of the top-50 Chinese brands are

only listed in HK, with a combined brand value of over US$300bn by Interbrand’s

valuation methodology.

Exhibit 32: Select HK stocks offer geographic exposure

diversification to A-share investors

Exhibit 33: Top-10 largest stocks in HK (ex H shares)

generated a large portion of their revenues overseas

Source: Bloomberg, FactSet, MSCI, Goldman Sachs Global Investment Research.

Exhibit 34: Upstream oil/gas companies, Macau gaming, and P&C insurance are not available in the A-share market

Source: FactSet, Wind, Goldman Sachs Global Investment Research.

0%

20%

40%

60%

80%

100%

95% 94%

63%

89% 88%

56%

0%

20%

40%

60%

80%

100%

MSCI China A MSCI China H MSCI Hong Kong

+ HSBC, SCB

By mkt cap

By revenue

2013 revenue exposure to China/HK(%)

12%

37%44%

5% 11% 6%

Exposure to

non- China/HK

0%

20%

40%

60%

80%

100%

CM

HK

HS

BC

Ten

ce

nt

CN

OO

C

AIA

Hu

tch

San

ds

SC

B

CK

H

SH

K

Others US Europe China/HK2013 revenue exposure (%)

GICS Sub-industry HK A

Oil & Gas Exploration & Production √ X 6 41,973 6,996 119 20

Casinos & Gaming √ X 8 58,718 7,340 320 40

Property & Casualty Insurance √ X 2 7,867 3,934 23 12

Total

industry

ADVT

(US$ mn)

Average

company

ADVT

(US$ mn)

Industry

availability# of

companies

Total

freefloat

market

cap

(US$ mn)

Average

Freefloat

market

cap

(US$ mn)



Value proposition #2: Underappreciated growth opportunities

A strong preference towards growth and small caps. Given onshore individual

investors are likely to be the key participants in the scheme (institutional investors can

invest overseas through QDII), we feel it is important to understand their investment

behavior.

Exhibits 36 and 37 compare the retail ownership of stocks based on their perceived

proposition to investors and their liquidity profile in terms of market cap and turnover

velocity. It seems clear that A-share retail investors have shown a strong preference

towards growth over value, and with noticeable small-mid-cap bias. Sectorally,

they seem to favor tech (both Semi and Hardware), ‘New China’ such as Internet and

Media, and select consumer sectors including retailing and staples, partly reflecting

the abovementioned style and liquidity partiality.

Growth stocks are in demand in China A. Onshore retail investors’ investment

preference, coupled with the fact that they represent 82% of the aggregate A-share

market turnover, has led to a phenomenon where high-growth, mid-cap stocks in

China A are trading at meaningfully higher valuations relative to their offshore-

listed comparables (including ADRs). From a PEG (price-to-earnings-growth)

standpoint, growth stocks in China A are priced at close to a 100% premium vs. their

offshore counterparts (Exhibits 39 and 40).

Potential re-rating of select growth stocks in HK. We think it is reasonable to expect

the A-H valuation gaps to gradually narrow, facilitated by the improving liquidity

porosity between China A and H on the back of the scheme. That said, considering the

investment style of both A and HK investors and the potential costs of engaging in that

trade, we believe the re-rating opportunities will likely manifest in:

Small/mid cap universe;

High-growth stocks;

Select sectors, mostly from non-traditional spaces that offer strong growth but

are priced at discounts to A.

Select dual-listed names that trade at H-share discounts to A.

Exhibit 35: A-share investors have shown a strong

preference to invest in high-growth, small-mid caps...

Exhibit 36: ...which leads to high turnover velocity of

those stocks

Source: Bloomberg, FactSet, I/B/E/S, Worldscope, Goldman Sachs Global Investment Research.

0

10

20

30

40

50

60

70

80

90

100

0 5 10 15 20 25 30 35 40 45

15

E E

PS

g (

%)

Market Cap (USD bn)





0

1

2

3

4

5

6

7

8

9

10

0 5 10 15 20 25 30 35 40 45

An

nu

ali

zed

tu

rno

ver

ve

locit

y

Market Cap (USD mn)







Exhibit 37: Retail investors are arguably the marginal

price setter in China A given their lion’s share of turnover

Exhibit 38: A-share investors seem to favor ‘New China’

sectors and tech companies

Source: CEIC, Goldman Sachs Global Investment Research

Exhibit 39: ‘New China’ and high-growth stocks are

generally priced more attractively in HK than in China A...

Exhibit 40: ...also with lower PEG ratios

Source: Wind, Goldman Sachs Global Investment Research


Exhibit 41: Select sectors in HK offer high growth but at discounts to their A-share peers

Source: Bloomberg, FactSet, I/B/E/S, Wind, Goldman Sachs Global Investment Research.

50

70

90

110

130

150

170

190

210

230

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

millions

Number of individual trading accounts

82%18%

as % of average daily trading volume in A shares in last 5 yrs

Retail investors

Institutional investors

30% 40% 50% 60% 70%

Software

Media

Semiconductors

Materials

IT Hardware

Retailing

Capital Goods

Durables

Telecom

Household Products

Professional Serv

Pharma

Properties

Auto

Consumer Services

Food & Staples

Div. Fin

Utilities

Beverage & Tobacco

Health Care Equip.

Banks

Transport

Insurance

Energy

A-share market

retail ownership

:54%

10

20

30

40

50

60

70

Jan

-11

Ap

r-1

1

Ju

l-11

Oct-

11

Jan

-12

Ap

r-1

2

Ju

l-12

Oct-

12

Jan

-13

Ap

r-1

3

Ju

l-13

Oct-

13

Jan

-14

Ap

r-1

4

Ju

l-14

"New China"

GSNEWCHN

Chinext

Trailing 12m P/E (X)

0.5

1.0

1.5

2.0

2.5Ja

n-1

1

Ap

r-1

1

Ju

l-1

1

Oct-

11

Ja

n-1

2

Ap

r-1

2

Ju

l-1

2

Oct-

12

Ja

n-1

3

Ap

r-1

3

Ju

l-1

3

Oct-

13

Ja

n-1

4

Ap

r-1

4

Ju

l-1

4

PEG (X)

Chinext

"New China"

GSNEWCHN

*PEG= trailing PE/ forward12m EPSg

Healthcare equip

Household Prod.

Personal Prod.

Pharm

Software

Specialty Retail

Tech H/W

Storage

Transport. Infra.

-100%

-50%

0%

50%

100%

150%

-100% -75% -50% -25% 0% 25% 50%

201

4 E

PS

gro

wth

dif

fere

nti

als

(HK

-lis

ted

off

sh

ore

-C

hin

a A

)

2014 PE premium/discount (%), HK-listed offshore vs. China A

Industry

Market

GSNEWCHN

vs. Chinext

HSMI vs. Chinext

China Offshore (HK-listed) vs. China A

HSCI vs. CSI300



Part 3: Think ahead and be prepared

#1: Future roadmap

While the Stock-Connect scheme is undoubtedly a major policy breakthrough in the

context of the Chinese capital market, we see this as one of the key steps and milestones in

the overall market liberalization regime, because:

It is an important piece of the broader reform puzzles in China, linking financial

market reforms (Rmb internationalization, market efficiency) and SOE reforms (foreign

capital participation and SOE restructuring), which we view as the top priority in the

policy agenda. Hence it is backed by strong political commitments, implying upside

risk to both the scale and scope.

Experiences of previously announced market liberalization measures, including QFII,

QDII, and RQFII, suggest the scheme could gradually expand, especially when the

relevant regulatory bodies gain confidence about the executional issues as it develops.

In numbers, we forecast the accumulative outward (from China) and inward equity

investment portfolio flows attributable to the scheme to exceed US$1tn and US$2tn

by 2020, translating into significant revenue opportunities for market intermediaries

including exchange operators and brokers.

Exhibit 42: The scheme is one of the major pieces in the broader reform agenda in China

Source: Goldman Sachs Global Investment Research

OB

JE

CT

IVE

SP

OL

ICIE

S/D

EV

ELO

PM

EN

TS

Key areas of reform

Fiscal reformsFinancial market

reformsSOE reforms

Land/rural/

hukou reforms

Division of responsibility and

spending rights between the

central and local govts, more

transparency and

accountability on spending

responsibilities, and a more

sustainable fiscal revenue

model.

Increasing the role of market

forces, improving transparency

and efficiency of financial

markets, reinforcing the

mutual beneficial relationship

between the real economy and

the financial market.

Raising competitions between

SOE and private companies,

enhancing SOEs' profitability

by introducing private

capital/expertise and instilling

cost awareness, and

encouraging M&As to solve

over-capacity.3,

Encouraging urbanization,

circulation of agricultural

land, developing intensive

farming, and bringing rural

commercial collective land

into the market to sustain

and rebalance growth.

VAT reform extended to

Telecom industry

Suggested budget

management and tax

collection system modifcation

Further discussion of

introducing property tax(by

State Council)

Allowing local govt to issue

debt on a trial basis

Expanded CNYUSD trading

band

Preferred share issuance pilot

program

SH-HK Stock Connect scheme

Nine new capital market reform

measures

Lowering ChiNext IPO access

indicator

Banks not allowed to use

backdoor transaction that

involves disguising corporate

loan

Bank's L/D ratio adjustment

S i SHFTZ

CITIC Pacific acquired CITIC

Group's entire asset

Opened up 80 state popjects

for private investment

PetroChina injected its Eastern

China's asset into a subsidiary

and allowed private

investment

Selected 6 SOEs as SOE

ownership reform pilots

Bank of Communications

applied for mixed ownership

pilot

State Council approved China

Everbright to be transformed

to shareholding company

Detailed urbanization plan

with concrete action plans

Announced Hukou and public

service transition procedure

Included agricultural

buildings into real estate

registration system



Exhibit 43: Big picture: The scheme is an important part of the broader financial/capital market reform

Source: HKMA, PBOC, CSRC, SFC, SSE, Goldman Sachs Global Investment Research

Exhibit 44: The scale of previously announced market liberalization measures has increased gradually over time

Source: Wind, NBS, CEIC, Goldman Sachs Global Investment Research

Exhibit 45: Further expansion in terms of scale, scope, and geographic linkages of the Scheme is likely, in our view


Apr 14Mar 13 Jun 13 Nov 13

Other liberalization

RMB liberalization

Equity market

QFII

announcedRQFII

expanded to

US$50bn

1. Settlement and

Clearing agreeement

on RMB business

between China and

Korea

2. PBOC abolished

pricing restrictions on

banks; FX

transactions with

corporates and

households

SH-HK Stock

Connect

Overnight RMB funds

on T+0 basis and one-

day funds on T+1 basis

provided for Authorized

Institutions

CNH HIBOR

fixing launched

Apr 04 Dec 05 Jun 07 Jul 09 Jul 10 Aug 11 Jul 12 Nov 12 Jan 13

Started Personal RMB

Business in HK

Expand HK personal

RMB Business

Settlement and Clearing agreement on RMB

business between PBOC and HKMA

RMB Trade Settlement

pilot scheme

Expand RMB Trade

Settlement Pilot

Scheme

RMB settlement expanded

to whole China

Announced pilot

scheme for RMB

settlement of QDII

Allow foreign

institutions to invest

in interbank bond

market with RMB

RMB bond issuance

in HK

First RMB-

denominated

REIT listed

RQFII announced

with initial quota at

US$20bn

Issued

guidance

on RMB FDI

Personal RMB

business expanded

to non-locals

RQFII to be expanded

to US$200bn

Qianhai

cross-

border yuan

loan

program

launched

Jul 14Apr 14Jun 13Mar 13

RQFII expanded to

financial institutions

registered and

with major operations

in HK.

Nov 02 Feb 04

Non-tradable

share reform

launched

SHFTZ was

set up

Providing

RMB 80bn and

RMB 80bn RQFII

quota to Korea

and Germany

respectively

- 10 20 30 40 50 60 70 80 90 100

-

10

20

30

40

50

60

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

QFII granted

quota

RQFII granted quota

USD bn USD bn

QDII granted

quota (RHS)

729

268

0

200

400

600

800

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

Number of QFII accounts

Number of QFIIs

0

20

40

60

80

100

120

0

5000

10000

15000

20000

May-1

0

Oct-

10

Ap

r-11

Oct-

11

Ap

r-12

Oct-

12

Ap

r-13

Oct-

13

Ap

r-14

CSI300 Future 20D

ADVT (RHS)

CSI300 Future

Open Interest

Expansion of quotas ETF inclusion

Geographical expansion (to include Shenzhen SE)

IPO inclusion

Further product expansion (to include equity derivatives, structured products ex ETFs)

Further geographical expansion (to include Singapore, Taiwan, London)

Succ

essi

ve s

tep

s in

S

han

ghai

-HK

Sto

ck

Co

nn

ect

schem

e

2015

2016

2017

Commodity trading link with HK

FIC trading link with HK

FIC and commodity link-ups with other exchanges

HK-Shanghai Stock Connect scheme - allows cash equity trading link-up between HK and SSE (Shanghai Stock

Exchange)

2014



#2: A-H valuation convergence

While the aggregate A-share premium has compressed significantly over time, the

upcoming Stock Connect has prompted investor questions on (and desire to trade) the

price equalization between dual-listed A and H shares, with the former currently trading at

a 24% premium on average but 8% discount to H weighted by total market cap.

Given the scope of this report, we focus on the practical aspects without going into the

theoretical arguments behind this phenomenon. Again, we feel it is important to

understand the following characteristics between the two markets:

Style difference: As shown in Exhibits 35 and 36, A-share investors generally prefer

growth over value, and small caps over large caps, while offshore investors in HK tend

to focus more on valuations, relatively speaking.

Marginal price setter: A-share retail investors are arguably the price setter in the

onshore market as they account for around 80% of the turnover, while HK is driven

more by institutional flows, which have an estimated 61% market share (in 2013) based

on the survey compiled by HKEx.

Cross-sectional analysis reveals that large-cap stocks with relatively low turnover

velocity usually trade at A-share discounts (H premiums) and vice versa, primarily

reflecting the difference of investment style and philosophy of the two investor pools, in

our view. This is the case for Financials but also applicable to Energy and Utilities.

The enhancing flows connectivity between the two exchanges should help improve the

price discovery efficiency and narrow the gaps between A and H. However, investors

should be mindful of the following caveats:

The two markets are still largely dominated by separate investor pools with different

investment philosophies.

Full legal fungibility (the ability to deliver either A or H shares to settle trades), which

would almost certainly make the shares trade within a narrower band (not always at

parity), is still absent.

It is difficult to predict in which direction the gaps may converge (i.e. whether A

falls or H rises, or a combination of both). Specifically, there are 4 possible ‘arbitrage’

scenarios:

1. Offshore investors sell the overvalued H and buy the undervalued A (large-cap

sectors like Financials and Energy). They may be incentivized to switch (assuming

they already have positions on H) but it depends on how high the switching costs

(transaction cost and market impact) might be. We think select well-held offshore

names could be disproportionately impacted by these arbitrage flows.

2. Offshore investors buy small-cap H shares (most are not well covered with thin

liquidity) and go short their expensive A-share counterparts, which practically

speaking is difficult to execute.

3. A-share investors go short the expensive large caps in HK and buy the

undervalued A shares in China, which doesn’t conform to their investment style.

4. A-share investors buy undervalued small-cap H, funded by their A shares,

which appears the most plausible scenario to us among the four.



Exhibit 46: A-H premium, while it still exists, has

compressed meaningfully over time

Exhibit 47: Small caps, which are favored (and frequently

traded) by A-share investors, tend to trade at valuation

premiums over their H-share counterparts

Source: Wind, Bloomberg, Goldman Sachs Global Investment Research.

Source: Wind, Bloomberg, Goldman Sachs Global Investment Research.

Exhibit 48: Cross-sectional regression model also

suggests market cap and turnover ratios are reasonable

explanatory factors for A-H premium

Exhibit 49: Price differentials exist even for fully-fungible

dual listings

Source: Goldman Sachs Global Investment Research.

Source: FactSet.

-20%

20%

60%

100%

140%

180%

220%

Au

g-0

4

Au

g-0

5

Au

g-0

6

Au

g-0

7

Au

g-0

8

Au

g-0

9

Au

g-1

0

Au

g-1

1

Au

g-1

2

Au

g-1

3

Au

g-1

4

Average Total-cap weighted

A/H Premium

24%

-8%

(1)

0

1

2

3

4

5

6

0 1 5 25 125 625

An

nu

ali

ze

d t

urn

ov

er

velo

cit

y

Total listed cap (US$bn), log scale

A-Premium H-Premium

Bubble size = A/H premium

Latest

premium

1Y Avg

premium

Total listed cap (Log scaled) -7.32 -5.94

Annualized turnover velocity 2.15 1.40

A/H share ratio 1.41 1.08

Consumer Discretionary 1.02 1.44

Consumer Staples -0.65 -0.51

Energy 0.13 0.04

Financials -1.23 -1.06

Health Care -0.03 -0.17

Industrials 0.40 -0.17

Information Technology 0.50 0.49

Materials 0.64 0.24

Utilities -0.76 -0.31

R Squared 0.63 0.53

Adjusted R Squared 0.56 0.44

T-stats

Cross-sectional

regression

Ma

rke

tS

ecto

r

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

55

65

75

85

95

105

Au

g-0

9

Dec-0

9

Ap

r-10

Au

g-1

0

Dec-1

0

Ap

r-11

Au

g-1

1

Dec-1

1

Ap

r-12

Au

g-1

2

Dec-1

2

Ap

r-13

Au

g-1

3

Dec-1

3

Ap

r-14

Au

g-1

4

Premium/Discount, UK vs. HK listed shares [Right]

HSBC (HK-listed)

Price (HKD) HSBC HKEx-listed vs. LSE-listed shares



#3: Market impact of liberalization

We believe the Stock Connect scheme will create a platform whereby A-share and global

investors can exchange investment philosophies, allowing the two investor pools to

assimilate and reshape the future development of the Chinese capital market. In the short

run, however, the collision of the two groups may usher in new dynamics to the market.

We examine two important events—allowance of direct foreign participation in local

equity market (e.g. QFII), and MSCI EM inclusion—in Korea’s and Taiwan’s respective

market liberalization processes, which may shed light on what may take place in China in

the next few years.

Market returns: Korea and Taiwan allowed foreign investors to directly purchase

domestic equities in 1992 and 1991 respectively subject to specific regulations. In the

same year, Korea was admitted to the MSCI EM universe and Taiwan was added in

1996. These two events appeared to have limited return impact on Korea while

Taiwan enjoyed a strong rally (and outperformance) on these catalysts.

Valuations: Taiwan’s rally was primarily fuelled by multiple expansion, and we note

there was similar re-rating in Korea, although it was short-lived and lasted for only 1-2

months.

Turnover velocity: We note there were meaningful increases in turnover velocity in

all the three episodes but the rise in trading activity only sustained for 2-3 months,

possibly reflecting investors’ initial excitement about the market liberalization

developments.

Volatility: Volatility rose significantly before the QFII implementation in Taiwan but

subsequently normalized. In the other two cases, volatility remained largely stable

around the events.

Return correlation: Contrary to common perception, the opening up of these two

markets didn’t introduce higher return correlation with global equities (we use MXAPJ

as a proxy). We think this reflects the positioning shifts of domestic investors in

anticipation of the liberalization measures, and the lagged effects between the

opening up and actual implementation by foreign investors when they enter into a

new market.

Foreigners drive market returns? Possibly longer term, but unlikely in China A in

the near future. While the relationships are far from stable, foreign investors’

influence on stock prices has been generally high in Asian markets in recent years,

much more so for Korea and Taiwan, mainly attributable to the relatively high foreign

ownerships in these two markets.

Given the QFII (based on granted quota) and the Northbound Stock Connect quotas in

aggregate represent 5.5% of free float A-share market cap, with much lower turnover

velocity than individual A-share investors, we believe the latter would remain a

dominant marginal price setter in the onshore market until foreign ownership reaches

more meaningful levels.



Exhibit 50: Taiwan rallied on its market liberalization

events...

Exhibit 51: ...and the returns were mainly driven by

valuation expansion


Source: DataStream, I/B/E/S, MSCI, Goldman Sachs Global Investment Research.

Exhibit 52: Turnover velocity rose immediately post these

market events but normalized thereafter

Exhibit 53: Volatility decreased after Taiwan

implemented the QFII system

Source: TWSE, KSE, WFE, CEIC, Goldman Sachs Global Investment Research.


Exhibit 54: Empirically, market return correlations with

global equities didn’t rise post the events

Exhibit 55: Foreign investors generally have high market

impact on most Asian bourses


Source: Bloomberg, Local stock exchanges, Goldman Sachs Global Investment Research

50

100

150

200

250

300

-24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24Months before/after market liberalization events

Rebased price index (LOC) (event dates = 100)

TWSE

(First time EM inclusion)

TWSE

(First time QFII)

KOSPI

(First time EM inclusion)0

10

20

30

40

50

60

70

80


f-12m P/E (X)

MXTW


MXTW

(First time QFII)

MXKR


0

1

2

3

4

5

6


Annualized turnover velocity, 3M moving average

TWSE

(First time EM

inclusion)

TWSE

(First time QFII)

KOSPI

(First time EM inclusion)10%

20%

30%

40%

50%

60%

70%


Annualized volatility, rolling 260D

TWSE


TWSE

(First time QFII)

KOSPI


-0.4

-0.2

0.0

0.2

0.4

0.6

0.8


Monthly price (US$) correlation vs. MXAPJ, rolling 2 years

TWSE


TWSE

(First time QFII)

KOSPI


0.0

0.2

0.4

0.6

0.8

1.0

Au

g-0

9

Feb

-10

Au

g-1

0

Feb

-11

Au

g-1

1

Feb

-12

Au

g-1

2

Feb

-13

Au

g-1

3

Feb

-14

Au

g-1

4Korea Taiwan India ASEAN Japan

Rolling 5Y monthly correl. (net foregin inflows vs. market returns)

KR TW IN TH PH JP CN

34% 37% 21% 19% 23% 31% 3%

Current foreign ownership (%)



#4: End game for B shares

The B-share market, founded in 1992, was originally designed specifically for foreign

investors, but domestic individuals have been allowed to participate since 2001.

However, we believe the market is losing its relevance (or its capital

raising/allocation function), as evidenced by its falling turnover, and decreasing

number of listed stocks. The Stock Connect scheme may further jeopardize its strategic

value, in our view.

We believe the inactivity of the B-share market is partly driven by the very narrow

universe (only 104 listed B shares), relatively more complex trading procedures

compared to A shares, and foreign currency risk for mainland investors, all

contributing to the valuation discounts that B shares are being priced at relative to

their A-share tickers.

B-to-H share conversion seems an effective tool to resolve this legacy issue. We

believe B to H conversion offers several advantages: 1) it allows companies to access

offshore financing, which is more favorable than onshore funding given the interest

rate spreads; 2) illiquidity overhang issues related to B shares would ease; and, 3)

listing offshore may enhance a company’s image.

Three companies have successfully converted their B shares to H in recent years

and created meaningful re-rating/trading opportunities during the process. Overall, we

believe B shares with stronger balance sheets (especially cash and current assets) are

better positioned for the conversion.

Exhibit 56: The relevance and importance of the B-share

market as a capital intermediary have declined

Exhibit 57: B-share discounts to A have gradually

normalized, but still at meaningfully high levels

Source: CEIC, Goldman Sachs Global Investment Research


98

100

102

104

106

108

110

112

114

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Number of B shares

6M ADVT

RMB mn

-75%

-70%

-65%

-60%

-55%

-50%

-45%

-40%

-35%

-30%

2009 2010 2011 2012 2013 201

Cap-weighed B-

to-A premium

(RHS)

Average B-to-A

premium



#5: Competition between Shanghai and HK

Our Global Macro team estimates that equity liquidity in China could reach US$165bn/day,

or roughly 70% of regional (Asia-Pacific) liquidity, in 2020, compared with 40% now; and

Shanghai could become China’s financial center and dominate China’s equity liquidity by

then. However, we do not think Hong Kong will be marginalized due to the rise of

Shanghai because:

As long as the “one-country, two systems” framework remains in place in Hong

Kong, and China continues to adopt its current judicial system (civil law based with

local characteristics and influence from the CPC) and regulation on information flow,

we think Hong Kong will remain the only Chinese city (or Special Administrative

Region) where the regulatory and judicial frameworks are aligned with Western

practices.

The rising prominence of Shanghai is predicated on China’s gradual and eventual

capital account convertibility. However, we do not think the opening up of the capital

account will lead to only one-way capital flow (into China) as:

Cross-country, empirical evidence suggests the relaxation of capital controls tends

to stimulate two-way portfolio investment flows;

Our interactions with domestic Chinese investors suggest that there is still

significant demand for outbound investment and asset diversification from

China, which should benefit Hong Kong in the long term.

Assuming ongoing policy support from China and the determination for the Chinese

government to reform its financial markets remains in place, we believe Hong Kong

has the necessary qualities to retain its status as a leading financial hub, specializing in

connecting China to the rest of the world given its status as China’s offshore Rmb

center, and providing asset management services to institutional investors and high

net worth individuals in the region.



Exhibit 58: Shanghai’s cash equity turnover is already 2X

that of HK...

Exhibit 59: ...but we still expect HK (HKEx) to capture a

significant portion (in nominal terms) of China’s outward

investment flows through the Stock Connect

Source: CEIC, Goldman Sachs Global Investment Research.


Exhibit 60: Removal of capital controls tends to stimulate two-way investment flows

Note: Year when all capital controls were lifted (T=0): UK: 1979; US:1974, France: 1990; Korea: 1993; Japan: 1991; Germany: 1981

Source: Bloomberg, Goldman Sachs Global Investment Research.

Exhibit 61: HK is still enjoying its first-mover advantage in terms of amassing Rmb liquidity, which seems sticky

Source: CEIC, HKMA, Monetary Authority of Singapore, SWIFT Watch.

0

20

40

60

80

100

120

140

160

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

Shanghai Shenzhen HK(RMB bn)

0%

20%

40%

60%

80%

100%

-

500

1,000

1,500

2,000

2,500

20

13

20

14

E

20

15

E

20

16

E

20

17

E

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E

20

24

E

Combined inward and outward flow at HKEx

HK's share of combined inward and outward flow -

RHS

(USD bn)

0%

10%

20%

30%

40%

50%

60%

70%

T-1

5

T-1

2

T-9

T-6

T-3

T=

0

T+

3

T+

6

T+

9

T+

12

T+

15

T+

18

T+

21

T+

24

T+

27

T+

30

T+

33

T+

36

T+

39

UK

US

Germany

France

Japan

Korea

Inward portfolio investment in

equities as % of GDP

0%

10%

20%

30%

40%

50%

60%T

-15

T-1

2

T-9

T-6

T-3

T=

0

T+

3

T+

6

T+

9

T+

12

T+

15

T+

18

T+

21

T+

24

T+

27

T+

30

T+

33

T+

36

T+

39

UK

US

Germany

France

Japan

Korea

Outward portfolio investment in

equities as % of GDP

0

200

400

600

800

1000

Ju

n-1

2

Sep

-12

De

c-1

2

Ma

r-1

3

Ju

n-1

3

Sep

-13

De

c-1

3

RMB bn

Hong Kong

Singapore

Taiwan

Total RMB deposits

China, 3%

Other

Countries,

24%

Hong

Kong,

73%

RMB adoption worldwide (Jan 2014)

Leading Offshore RMB CentresCustomer initiated and institutional payments. Inbound + Outbound traffic. Based on value.

Other countries split

4%

4%

6%

7%

4%

4%

23%

31%

3%

3%

5%

7%

7%

9%

25%

26%

0% 5% 10% 15% 20% 25% 30% 35%

Germany

Luxembourg

Australia

France

USA

Taiwan

Singapore

UK

Jan 2014

Jan 2013

RMB top offshore centres weight and rank

(excluding China and Hong Kong)



#6: Human capital and capex

We expect China to account for almost 25% of global equity market capitalization by

2030, primarily led by its robust economic growth and continuing financial market

deepening, coupled with what we view as reasonable assumptions on normalized equity

valuation. Against that backdrop, we see significant business opportunities centering on

the following areas:

DM investment flows (both new buying as well as customary portfolio trading);

Growth in domestic EM institutional business as domestic saving pools become more

institutionalized;

Addressing the domestic retail investor base;

Primary issuance, placements;

Derivative and structured product businesses as equity and related options and futures

markets become larger and more liquid;

Proprietary activities;

Related businesses- including stock loan, custodial services, foreign exchange

settlements, and advisory work- that will be driven by larger and deeper equity markets.

To give a rough sense of the magnitude of the potential ‘plain vanilla’ revenues, we have

calculated potential fees on: a) the US$3.9tn of primary issuance that we estimate may

transpire over the next 15 years; and, b) secondary market commissions (based on average

market cap, 100% annual turnover ratio and 10bp commission rate. Using conservative

estimates, these add up to about US$360bn of revenues over the next 15 years or a simple

average of US$24bn annually. Given the diverse array of generally more profitable

businesses that complement these core equity intermediary activities, the business

opportunity is clearly meaningful and could be several multiples of these base figures, in

our view.

That said, competitive pressures will probably intensify and the competitive landscape

will gradually evolve as the revenue opportunities become more recognized. Specifically:

Stronger local players will no doubt emerge and change the competitive landscape,

leading to more M&A and international expansion.

The ‘war for talent’ will also become a real issue as financial intermediaries compete

to attract capable and experienced people, especially for those who can apply ‘local’

knowledge and investment framework to the increasingly integrated HK/China market.

The incentive and pressure for localization will increase for global investors:

Coverage footprints will expand, demand for local language capabilities will increase

as the client mix shifts more towards domestic institutions, and management

pressures (for global or regional intermediaries) will intensify given inevitable tensions

between local norms/objectives and a given firm’s broader culture and goals.

The potential revenue opportunity will likely come with a higher cost base, since a

greater local focus makes it harder to have scale efficiencies across geographic borders,

i.e. a ‘hub and spoke’ model will become more difficult to deploy. This will also make it

harder for financial firms to manage through the cycles that will inevitably take place

within the context of the longer term structural trends.



Exhibit 62: Economic growth tends to lead to

financial/capital deepening

Exhibit 63: We forecast China to represent almost 25% of

global market cap by 2030

Source: WFE, IMF, Goldman Sachs Global Investment Research

Source: PBOC, various Central Banks, WFE, IMF, Goldman Sachs Global Investment Research

Exhibit 64: China already has an active and sizeable equity market, but it needs more soft

infrastructure capex to support further growth

Note: * referring to the whole country; # referring to SH only.

Source: HKMA, WFE, AsiaBondOnline, TheCityUK, SFC, CEIC, Wind, CFA institute, GS Global Investment Research.

Exhibit 65: International brokers may need to increase their coverage footprint in China A

Source: Bloomberg.

4,000

6,000

8,000

10,000

12,000

14,000

16,000

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

Cap to GDP ratios, adjusted for valuations

Cap to GDP ratios, unadjusted

GDP per capita (right)

Cap to GDP ratios GDP per capita (USD)

A clearer relationship

Less clear relationship

N. America

DM Europe

DM Asia

Other EM

Brazil, Russia,

and India

China

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

19

90

19

95

20

00

20

05

20

10

20

15

20

20

20

25

20

30

As % of global market cap share

25%

11%

17%

7%

15%

25%

Forecast

EM

53%

DM

46%

China (SH+SZ) Hong Kong Singapore London New York

Equity market cap (US$bn)

Dec 133,949 3,101 744 4,429 24,035

Avg daily equity market turnover (US$bn),

201331.8 6.1 1.1 12.3 169.5

Issuance, IPO + FO (US$ bn), 2013 70.2 48.8 7.4 47.5 190.3

# of companies >US$1bn by market cap 901 377 94 422 2,317

# of companies >US$1bn by free float cap 337 230 51 363 2,097

Size of bond market as % of GDP, 2013* 50% 71% 83% 242% 216%

Avg daily FX turnover (US$bn), 2013* 44 275 383 2,726 1,263

Assets under management (US$tr), 2012* 0.6 1.5 1.2 7.3 39.6

Employees in the financial sector (000') 294# 239.9 190.1 367.7 599.0

Finance employees as % of total 5.3%# 6.4% 5.4% 7.4% 6.6%

Total number of CFA* 2,919 5,777 3,235 7,219 55,013

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 >30

# of Bloomberg estimates

HSCI

CSI300

CSI300 ex A-H dual listed

# of stocks



Appendix

Exhibit 66: China A could add positive portfolio effects even during market upturns, mainly due to their low return

correlations with regional and global peers

Annualized (total) returns (US$) and volatility, MSCI universe, past 10 years

Note: Returns are expressed in annualized total returns (CAGR) for MSCI indexes in US$; Risk: annualized standard deviation of monthly returns; Correlation: between monthly returns of both asset classes; Optimal weights are calculated based on a hypothetical two-asset-class portfolio that maximizes the Sharp ratio with risk-free rate being assumed to be the period’s monthly average three-month US Treasury Bill yield.


China-A China-H China-A MXAPJ China-A MSCI EM China-A

MSCI AC

World

# of

months

Return 43% 45% 43% 45% 43% 47% 43% 32%

Risk 28% 20% 28% 18% 28% 20% 28% 13%

Correlation 40% 33% 31% 33%

Optimal weight 21% 79% 19% 81% 21% 79% 14% 86%

Return 14% 21% 14% 18% 14% 20% 14% 13%

Risk 32% 27% 32% 18% 32% 20% 32% 12%


Optimal weight -16% 116% -5% 105% -4% 104% 3% 97%

Return -53% -49% -53% -51% -53% -54% -53% -41%

Risk 36% 37% 36% 31% 36% 34% 36% 25%


Optimal weight 69% 31% 35% 65% 39% 61% 32% 68%

Return 8% -31% 8% -37% 8% -40% 8% -42%

Risk 27% 30% 27% 26% 27% 25% 27% 20%

Correlation 34% -3% 2% -28%

Optimal weight NM NM NM NM NM NM NM NM

Return 13% 14% 13% 12% 13% 12% 13% 8%

Risk 32% 27% 32% 22% 32% 24% 32% 17%


Optimal weight 23% 77% 26% 74% 31% 69% 39% 61%

Expansion

Slowdown

Contraction

Recovery

Full period

46

54

12

8

120



Equity basket disclosures

The ability to trade the basket(s) discussed in this research will depend upon market

conditions, including liquidity and borrow constraints at the time of trade.

The Securities Division of the firm may have been consulted as to the various components

of the baskets of securities discussed in this report prior to their launch; however, none of

this research, the conclusions expressed herein, nor the timing of this report was shared

with the Securities Division.

MSCI disclosure

All MSCI data used in this report is the exclusive property of MSCI, Inc. (MSCI). Without

prior written permission of MSCI, this information and any other MSCI intellectual property

may not be reproduced or redisseminated in any form and may not be used to create any

financial instruments or products or any indices. This information is provided on an “as is”

basis, and the user of this information assumes the entire risk of any use made of this

information. Neither MSCI, any of its affiliates nor any third party involved in, or related to,

computing or compiling the data makes any express or implied warranties or

representations with respect to this information (or the results to be obtained by the use

thereof), and MSCI, its affiliates and any such third party hereby expressly disclaim all

warranties of originality, accuracy, completeness, merchantability or fitness for a particular

purpose with respect to any of this information. Without limiting any of the foregoing, in

no event shall MSCI, any of its affiliates or any third party involved in, or related to,

computing or compiling the data have any liability for any direct, indirect, special, punitive,

consequential or any other damages (including lost profits) even if notified of the

possibility of such damages. MSCI and the MSCI indexes are service marks of MSCI and its

affiliates. The Global Industry Classification Standard (GICS) were developed by and is the

exclusive property of MSCI and Standard & Poor’s. GICS is a service mark of MSCI and

S&P and has been licensed for use by The Goldman Sachs Group, Inc.



Disclosure Appendix

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