[HONG KONG] Despite its lukewarm start, the landmark scheme connecting the Shanghai and Hong Kong stock markets is paying dividends for foreigners interested in another asset class - Chinese bonds and other fixed-income products.
Hedge funds which had nearly exhausted their China investment quotas have been able to use the Stock Connect to juggle their portfolios and snap up Shanghai-listed convertible bonds, one of the hottest products in Asia markets in the past month as Chinese share prices went through the roof.
Hedge funds aren't alone in their appetite for Chinese bonds, despite worries about the impact of the cooling economy on credit quality.
The biggest foreign investment quota holder in China, Hong Kong-based CSOP Asset Management, last week launched an exchanged-trade fund (ETF) targetting ultra short-term bonds in the world's second-largest economy.
"The new bond ETF became available thanks to the Stock Connect, which freed up some of our RQFII quota" by offering another channel for investment, a person with direct knowledge of the matter at CSOP told Reuters.
In the alphabet-soup of Chinese investing, the RQFII or Renminbi Qualified Foreign Institutional Investor scheme allows foreign investors and central banks who hold the yuan currency to re-invest it in Chinese capital markets.
The RQFII quota for Hong Kong, the world's biggest offshore yuan centre, has been almost exhausted since September, when China's State Administration of Foreign Exchange (SAFE) allocated all the 270 billion yuan (US$43.18 billion) quota to asset managers based in the former British colony.
As a result, some fund managers had to turn down their clients' new orders in the past few months when China's A-share market surged to more than five-year highs.
Before the Shanghai-Hong Kong Stock Connect was launched last November, the RQFII and its older cousin the QFII (Qualified Foreign Institutional Investor) programme were the main channels through which overseas investors could invest directly in China.
Foreign investors under RQFII can make investments in China's bond and stock markets at their own discretion; while QFII investors have to invest at least 50 per cent of their funds in equities and hold no more than 20 per cent in cash.
Equity products account for the lion's share of RQFII products, compared to bond products. CSOP, for example, saw more than 80 per cent of its quota used for stock products before the new bond ETF.
But analysts say that may change if fixed-income products prove lucrative and more investment quotas can be re-allocated to bond market with the help of the Stock Connect.
Market participants are expecting further monetary loosening measures from Beijing after the world's second-largest economy recorded its slowest growth in 24 years, benefiting bond markets.
In addition to the convertible bonds that hedge funds stampeded into with the hope of benefiting from booming stock prices, other fixed-income products foreign investors like are mainly investment-grade ones, such as government bonds or policy bank bonds. "The Hong Kong intermediaries (that facilitate foreign investment to China) have been very, very busy in the last two months," said Tae Yoo, head of client business development & fixed income and currency development at the Hong Kong Stock Exchange.
"Many of the hedge funds have been very active using Stock Connect as a portion of their QFII quota and using QFII quota to access Shanghai's convertible bonds. There's a lot of demand coming in and the market wants to have more," Mr Yoo said.
A convertible bond is a bond with an embedded stock option that enables its holders to convert it to a common stock of the company that issues it.