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COMMENTARY

Chinese investors are playing a game of hot potato

THE star that burns the brightest may also burn out fastest. Investors tempted by the blazing debut of China's new tech board should bear that in mind.

The first 25 companies to start trading on Shanghai's STAR market posted an average gain of 140 per cent on Monday. The value of shares that changed hands surpassed 48 billion yuan (S9.52 billion) - about 13 per cent of the total trading volume on Chinese exchanges, which contain more than 3,800 listed securities and have a combined market capitalisation of more than US$6.6 trillion. 

To some extent, this shouldn't be a surprise. Playing IPO stocks is a national pastime in China. After Terry Guo's Foxconn Industrial Internet Co made its debut in Shanghai in June 2018, as much as 55 per cent of the semiconductor manufacturer's shares traded daily. Seen in that light, Monday's 80 per cent turnover ratio for Star stocks isn't that remarkable - companies on the Nasdaq-style board are much smaller than the US$35 billion Foxconn unit.

For the STAR board to be a long-term success, it needs to maintain that level of liquidity. China's track record on this front isn't good, though. After a frenzied start, trading in newly listed shares tends to collapse. There are many examples. Daily turnover for Foxconn has evaporated to about 2 per cent. Shenzhen Mindray Bio Medical Electronics Co, which withdrew its US listing to return home to China, has seen trading dwindle to minuscule levels since a high-profile IPO in October.

Why Chinese investors love to bet on newly listed stocks

It's worth asking why Chinese investors love to bet on newly listed stocks, a practice known as da xin. IPOs have been subject to an unofficial valuation ceiling of 23 times earnings, regardless of how fast companies are growing. That's meant systematic undervaluation and a one-way bet when they come to market. But the price-earnings cap has been removed for the Star market, which follows the US registration-based model. So why are investors still piling in?

The sad reality is that China's stock market isn't a good place for long-term investing. Unlike the US, where investors can reliably expect a 5 per cent cash yield from dividends and share repurchases, buy and hold is a losing strategy. Over the past 12 years, investors get back only 38 cents for every dollar they give to companies, data provided by Citic Securities Co show. China Inc isn't into cash rewards.

In other words, companies treat public investors as free ATM machines. So for investors to make money, they have to punt on share-price gains. Da xin is essentially a process of passing hot potatoes to the next investor.

The STAR board, the brainchild of President Xi Jinping, is considered a key policy in China's new supply-side reform. In Beijing's view, insufficient market-based financing has contributed to China's ballooning debt problem. Two-thirds of corporate financing comes in the form of bank loans. The STAR board is intended to spur direct financing, where companies raise money from investors through corporate bond and stock offerings.

It's not the first such attempt. The ChiNext board in Shenzhen started almost a decade ago to provide an alternative fundraising venue for smaller firms. It's since fallen out of favour. China's stock market will need more fundamental change if Shanghai's STAR is to avoid the same fate. BLOOMBERG