Heptagon pioneers the Chinese A Shares space

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As anticipation builds over a programme connecting the Shanghai and Hong Kong stock exchanges, known as the ‘through train’, Heptagon Capital has recently partnered with the third largest asset manager in China, Harvest Global Investments, to launch the Harvest China A Shares Equity Fund.

The fund, Heptagon says, is the first Ucits fund vehicle to follow an actively managed strategy in the China A Shares equity market, which provides for daily liquidity under the RQFII programme.

The hype around the China A Shares equity market, as well as the ‘through train’ project, is down to the fact that A-shares, Chinese stocks restricted to the domestic market, are considered cheap. A-shares offer a higher exposure to the consumer services, consumer goods, healthcare and industrials sectors than the H-share market, the Heptagon partners explained.

Moreover, the Chinese government has recently taken measures to open up the A-shares market to foreign investors, who currently hold barely 1% of it, according to Heptagon.

Heptagon’s fund will aim to build on the success of Harvest’s ‘Research Select’ strategy, the equity portion of which has outperformed the CSI 300 index by 75% since inception in May 2008.

“This is the first ever daily traded, actively managed, pure China A share Ucits fund for UK and EU investors. Harvest are a well known and widely respected active equity manager based in Beijing with a great track record in finding good A share companies,” said Warwick Ryan (pictured), managing director at Heptagon.

“The fund is a plain vanilla, so pure play, just stocks, no P Notes, no swaps, no H Shares or US shares or B shares and no derivatives,utilising the brand new July 2014 RQFI rules, which means that the fund should be able to grow easily using Harvest’s generic quotas,and henceforth without necessarily having to go back and get more fund vehicle specific QFI or RQFI quota from the Chinese regulators.”

While Ryan says the launch came in response to the regulatory environment in China, he adds that the continual levels of growth, at around 7.5%, in China has helped to refocus investor attention on the country’s equity market, making it more attractive for the company to launch in the A Shares space.

Moreover, the MSCI announcement in August has meant that they will leave the A Share inclusion in their indices on watch for another year. This was seen as a positive sign and proves that recent moves to open up the market by the Chinese, and open mindedness by the index providers, ought finally be a precursor at some point in the next 12 months to some type of A-shares inclusion in the broader MSCI Emerging Markets index.

Over the last five years, the CSI 300 index of leading China A Shares has declined 20%, even while the S&P 500 was up over 132% and the MSCI World up 97%, in dollar terms. Despite a late summer rally, the Shanghai composite has been trading close to its cheapest level on record, relative to the MSCI Emerging Markets index, even while the world’s second largest economy is still projected to grow 7.5% year on year.

“The bearish Chinese equity thesis that has driven valuations to this decade low has been re-visited by many institutional investors, as well as by index providers like MSCI, ergo, the timing of this pioneering product is really good,” Ryan says.

Although he acknowledges it is a fairly extreme hypothetical case, if the current quota system were to be totally abolished and various accessibility restrictions lifted, MSCI estimate that China A-shares could represent up to 13% of the MSCI Emerging Markets index, he adds.

At the moment, the fund mainly targets institutional investors, such as pension funds, wealth managers, and insurers “as the Chinese market currently carries a higher risk compared to a UK or Italy domiciled funds.” In general, Ryan explains, the type of investors that will buy into this fund are in search of low correlation to the S&P 500, trading at record highs, and they are in discussion with seed investors based in the UK, Europe and Middle East, with a particular focus on northern Europe.

Outlining expectations, Ryan says that Heptagon aims at achieving $150m AUM for the fund by the middle of next year. “In the next five years, we aim at being a standout performer, but that will depend on competitors. Many investors also tend to just buy Asia funds, rather than say a pure play in China or Greater China, so we acknowledge that for many, smaller investors, China will be a satellite position to diversify their sources of alpha,” he concludes.

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