Hong Kong ETF shows global traders just don't like city's stocks

[HONG KONG] Whether Hong Kong stocks rally or slump, investors in the biggest US exchange-traded fund tracking the equities just want out.

Traders have pulled a net US$142 million from the iShares MSCI Hong Kong ETF in May, poised for an 11th straight month of net outflows and the longest string of declines on record. While the underlying stock index has fallen 2.6 per cent this month, investors were net sellers even in March, when the gauge staged its biggest rally in four years.

For Standard Life Investments Ltd, Hong Kong is suffering from a surfeit of bad news. China's slowdown is affecting everything from trade to retail sales, a dysfunctional political system is delaying bills and spurring calls for independence, while Goldman Sachs Group Inc is predicting house prices will tumble 20 per cent in a city where business is dominated by a handful of property tycoons.

"In the course of last year or so, there's been little good news and a whole series of worrying," said Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life, which manages about US$365 billion.

"It's no surprise that some people have said, I think this story has reached the end and I need to invest elsewhere."

The US-listed ETF tracks the MSCI Hong Kong Index, which represents largely local companies including Hong Kong Exchanges & Clearing Ltd, developer Sun Hung Kai Properties Ltd. and utility CLP Holdings Ltd. The gauge tumbled 3.4 per cent last week, spurring investors to pull a net US$125 million from the ETF - the second-largest net sales in a year.

Net outflows since the end of June last year now total US$1.5 billion. A 9 per cent surge by the gauge in March failed to entice investors, who yanked US$31 million that month. The index is down 2.9 per cent in 2016.

Investors are turning to other country ETFs, with developing-nation funds in particular luring capital, says Joshua Crabb, Hong Kong-based head of Asian equities at a unit of Old Mutual Plc. The iShares MSCI Emerging Markets ETF drew net inflows of $2.6 billion this year, while Vanguard FTSE Emerging Markets ETF is on course for a third straight month of inflows, data compiled by Bloomberg show.

In recent years, buying and holding Hong Kong shares has been a poor investment compared with major peers. The MSCI Hong Kong index has risen 4.3 per cent in total over the past five years, compared with average annual inflation of 4.2 per cent during the period. The MSCI All-Country World Index advanced 14 per cent, with Japan's Topix index and the S&P 500 climbing more than 50 per cent.

Valuations make the case for buying Hong Kong stocks. Their lagging performance has left the MSCI measure of the city's shares trading at a 38 per cent discount to MSCI Inc.'s global gauge on a price-earnings basis. The city also comes out well on Transparency International's corruption perceptions index and its foreign currency debt is rated AAA by S&P Global Ratings, while many of its largest companies have overseas earnings that shield them from a stuttering local economy.

Still, challenges are piling up for Hong Kong's economy, which is projected to grow at its slowest pace in four years this year. Retail sales plunged 12.5 per cent in the first quarter amid falling numbers of mainland visitors. China's suspected abduction of booksellers from the city has raised international concern about the strength of Hong Kong's rule of law, while filibustering by opposition lawmakers is holding up bills.

For Fountainhead Partners, it's uncertainty over the property market that makes Hong Kong stocks most unappealing to foreign investors. Home prices have fallen 13 per cent from last year's peak and analysts warn the worst is still to come. Higher US interest rates would boost borrowing costs, thanks to the Hong Kong dollar's peg to the greenback. Real estate developers and owners have a 27 per cent weighting in the MSCI Hong Kong index.

"Global investors don't look at Hong Kong as an ideal market because Hong Kong is mostly driven by real estate and trade," said Pu Yonghao, chief investment officer of Fountainhead Partners, which oversees about US$600 million. "The property index is already coming down, so why should people buy Hong Kong?"

BLOOMBERG