How much allocation space is there for foreign capital in Hong Kong stocks?

The notable changes in the funding situation last week are: 1) According to EPFR data, as of this Wednesday (February 19), active foreign capital continued to flow out of the Chinese market overall, but the outflow scale has narrowed; meanwhile, passive foreign capital accelerated inflows; 2) In terms of connectivity, the average daily trading volume of northbound funds increased compared to last week, and southbound funds accelerated significantly, with a single-day inflow on Tuesday reaching a new high since January 2021; 3) Global stocks turned to inflows, while bonds and money markets continued to see inflows; 4) U.S. stocks turned to inflows, while emerging markets saw a slowdown in outflows.

In the domestic funding situation, southbound funds accelerated inflows. This week, southbound funds saw a significant inflow of HKD 51.21 billion, more than double the inflow of HKD 21.77 billion last week. The previous week, southbound funds had briefly flowed out, possibly related to some investors who bought in early October realizing profits. On this basis, driven by the continued rise in the market this week, especially the boost from Alibaba's earnings report on Friday, southbound funds accelerated inflows, with a significant inflow of HKD 22.42 billion on Tuesday alone, reaching a new high since January 2021. The outflow again on Thursday indicated a widening divergence, but on Friday, boosted by Alibaba, southbound funds flowed in again with HKD 14.04 billion.

Chart: Southbound funds accelerated inflows

Source: EPFR, Wind, CICC Research Department; Data as of February 19, 2025

Overall, the proportion of southbound trading in the total trading volume of Hong Kong stocks has maintained at around 30% since it rose from 20% in November last year. This week, the proportion of southbound trading slightly increased by 2.3 percentage points to 31% compared to last week, while the market value of southbound holdings accounted for about 10% of the total market value of Hong Kong stocks, without a significant increase. At the individual stock level, this week, southbound funds were concentrated in buying, with significant inflows into Alibaba, China Mobile, SMIC, Kuaishou, etc., and outflows from Meituan, Tencent Holdings, etc. Among them, Alibaba saw a significant inflow of HKD 17.3 billion this week, accounting for one-third of the net inflow of southbound funds for the week, and the proportion of southbound holdings in Alibaba also increased from 5.2% last Friday to 5.8%, up 0.6 percentage points.

Chart: The proportion of southbound funds in the Hong Kong Stock Exchange main board trading is about 30%

Source: Wind, CICC Research Department

Chart: The market value of southbound holdings accounts for 10% of the total market value of Hong Kong main board

Source: Wind, CICC Research Department

Chart: The proportion of holdings in the top ten most active stocks this week increased

Source: Wind, CICC Research Department

Foreign capital basically continues the previous trend, with active foreign capital continuing to flow out but at a reduced scale, while passive foreign capital accelerates inflow. As of this Wednesday (February 19), in the Hong Kong stock market: 1) Passive funds (ETFs) accelerated inflow, with the inflow of passive foreign capital into Hong Kong stocks and ADRs rising from $540 million last week to $910 million, mainly focused on funds investing in China and Chinese concept stocks, aligning with investors' characteristics of using these two indices to speculate on the technology market; 2) Active funds (mainly long-only) saw a narrowing outflow, with outflows primarily from funds focused on China and emerging markets, while inflows were mainly from Chinese concept funds. Therefore, although some trading desks report that some long-term funds have turned to inflow, according to EPFR statistics, the total active foreign capital has not yet returned; 3) The short-selling ratio dropped significantly from Tuesday's high of 19% to Friday's 13.7%, which may indicate a short squeeze and hedge fund liquidation. In comparison, the inflow of passive foreign capital into A-shares remained the same as last week, at only $430 million, while active foreign capital accelerated outflow.

Chart: Expansion of Active Foreign Capital Outflow from A-shares

Source: EPFR, Wind, CICC Research Department

Chart: Continued Outflow of Active Foreign Capital from Hong Kong Stocks + ADRs

Source: EPFR, Wind, CICC Research Department

Chart: Short-selling ratio dropped significantly from Tuesday's high of 19% to Friday's 13.9%

Source: Bloomberg, CICC Research Department

How much allocation space does foreign capital have? As of December 2024, the proportion of Chinese stocks held by major global active funds that can invest in Chinese stocks is 6.1% of their asset scale, which is 1.1 percentage points lower than the corresponding benchmark index (i.e., underweight), and this proportion remains at a historical low, far below the peak of 14.6% in early 2021. Assuming that foreign capital gradually turns optimistic and is willing to increase allocation, we estimate: 1) Scenario One: Since active funds targeting global and Asian markets (excluding Japan) are overweight in South Korea and India, if subsequent active foreign capital reduces allocation to these two markets to near a five-year low, the funds will rebalance to China, corresponding to an inflow of $6.3 billion, close to the outflow scale since October 2024 (which is $8.8 billion); 2) Scenario Two: Currently, the underweight of 1.1 percentage points is fully converted to benchmark weight (as of the end of 2021), corresponding to an inflow of $40.3 billion, which is equivalent to the total outflow from the Chinese market since 2021 under the EPFR standard (approximately $41.9 billion). However, it is important to note that the premise for active foreign capital to return is that the trends in the AI industry and macro narratives need to be further realized to provide more catalysts.

Chart: The current allocation ratio of active funds to China is approximately 1.1 percentage points below the benchmark.

Source: EPFR, CICC Research Department

Additionally, it is worth noting that on February 21, the Hang Seng series indices announced quarterly adjustment results. Due to the restriction that the weight of individual stocks in the Hang Seng Index and the Hang Seng TECH Index cannot exceed 8%, stocks that have recently risen significantly and exceeded the 8% weight (such as Alibaba, Tencent, HSBC, Xiaomi, SMIC, etc.) will lead to a passive "reduction" in weight on the adjustment execution date (March 7).

Global capital situation: US stocks have turned to inflows, while Japanese and Indian stocks are accelerating outflows. As of this Wednesday (February 13-19), the outflow of active foreign capital from the Indian market slightly expanded to $510 million (vs. $430 million outflow last week), US stocks turned from an outflow of $40.87 million in the previous week to an inflow of $1.45 billion, and the Japanese stock market accelerated its outflow to $138 million (vs. $72.61 million outflow last week).

Active foreign capital continues to flow out, while passive inflows accelerate; Southbound inflows accelerate

Overseas funds: EPFR shows that active foreign capital continues to flow out but at a reduced scale, while passive inflows accelerate. As of this Wednesday (February 13-19), active foreign capital in A-shares accelerated its outflow to $130 million (vs. $80 million outflow last week), while passive capital inflow was $430 million (vs. $430 million inflow last week); at the same time, the overall inflow of overseas funds into Hong Kong stocks and ADRs expanded to $680 million (vs. $280 million overall inflow last week), of which active funds slightly slowed their outflow from $260 million last week to $230 million, while passive capital inflow significantly accelerated, nearly doubling from $540 million last week to $910 million.

Chart: This week, active foreign capital continues to flow out of the A-share market, but passive foreign capital has significantly flowed in.

Source: EPFR, CICC Research Department

Connect funds: Northbound funds have stopped disclosing net buying amounts since August 16, 2024, and the average daily trading volume this week has increased compared to last week. This week, the trading amount of northbound funds was approximately 218.16 billion yuan, a slight increase from last week's average daily trading amount of 201.56 billion yuan. In terms of individual stocks, BYD, CATL, Northern Huachuang, and Kweichow Moutai had the largest trading volumes Chart: Weekly Average Daily Trading Volume of Northbound Funds

Source: Wind, CICC Research Department

Significant Acceleration of Southbound Inflows. This week, southbound funds inflowed HKD 51.21 billion, with an average daily inflow of HKD 10.24 billion, doubling from the previous week's average daily inflow of HKD 4.35 billion. On Tuesday, the single-day inflow of southbound funds reached HKD 22.42 billion, a new high since January 2021, but it turned into a net outflow on Thursday. At the individual stock level, there was a significant inflow into Alibaba and China Mobile this week, while Meituan and Tencent Holdings saw outflows. At the industry level, this week, southbound funds increased their holdings in consumer and mainland banks the most, while reducing holdings in energy, materials, and automobiles.

Chart: Changes in Southbound Fund Holdings This Week

Source: Wind, CICC Research Department

Global Stocks Turn to Inflows, Bonds and Money Markets Continue to Inflow; US Stocks Turn to Inflows, Emerging Markets Outflows Slow

Cross-Market and Asset: US Stocks Turn to Inflows, Developed Europe, Japan, and Emerging Markets Continue to Outflow. In terms of active foreign capital, US stocks turned to inflows of USD 1.454 billion this week (vs. outflow of USD 0.041 billion last week), developed Europe accelerated outflows of USD 1.319 billion (vs. outflow of USD 1.022 billion last week), Japan's stock market accelerated outflows of USD 0.138 billion (vs. outflow of USD 0.073 billion last week), and emerging markets saw outflows slow to USD 1.305 billion (vs. outflow of USD 1.355 billion last week). In terms of cross-assets, global stocks turned to inflows, while bonds and money markets continued to see inflows.

Chart: Weekly Net Subscription Status of Global Stocks, Bonds, and Money Market Funds

Source: EPFR, CICC Research Department

Allocation Ratio: As of December 31, 2024, the allocation ratio of various major types of active funds globally to China is about 1.1ppt lower than the benchmark, basically flat compared to the underweight of 1.2ppt at the end of November. In terms of allocation ratio, active funds with a global investment direction increased their allocation to France (+0.23ppt) and Japan (+0.09ppt) more, while reducing their allocation to the United States (-0.49ppt) and the United Kingdom (-0.10ppt) more; in terms of ultra-low allocation ratios, in December, France (+0.17ppt), Australia (+0.06ppt), and Germany (+0.04ppt) saw more increases in ultra-low allocation ratios, while the United States (-0.44ppt), the United Kingdom (-0.08ppt), and South Korea (-0.07ppt) saw more declines in ultra-low allocation ratios. In terms of regional types, funds managed by managers from Europe are the main force of overall outflows; From a sector perspective, overseas funds are overweight in China's healthcare, consumption, semiconductors and hardware, and capital goods, while underweight in the internet, finance, and real estate.

Chart: The allocation ratio of active funds to China and India has declined, while Japan's underweight ratio has also decreased.

Source: EPFR, China International Capital Corporation Research Department

Source: China International Capital Corporation Strategy, Kevin Strategy Research, Original Title: CICC: How Much Allocation Space Do Foreign Funds Have?