CICC: How much more room is there for southbound inflows?

After breaking through 24,000 points to set a new high the previous week, Hong Kong stocks experienced a volatile pullback last week. Although the market rebounded significantly last Friday, on the index level, the Hang Seng TECH Index fell by 2.6%, the Hang Seng Index dropped by 1.1%, and the Hang Seng China Enterprises Index and MSCI China Index decreased by 0.4% and 0.1%, respectively.

On the sector level, consumer staples (+3.8%), diversified financials (+3.5%), and insurance (+3.5%) led the gains, while media and entertainment (-1.9%), information technology (-1.7%), and consumer discretionary (-1.1%) lagged behind. There were signs of a spread to broader consumer stocks on Friday, while the previously leading technology sector lagged.

Chart 1: Last week, consumer staples and diversified financials led the gains in Hong Kong stocks, while media, entertainment, and information technology declined Source: FactSet, Bloomberg, CICC Research Department

However, what is "inconsistent" with the market trend is that southbound funds continue to flow in significantly, becoming a focal point. Following a record net inflow two weeks ago that set a new high since 2021, last Monday (single-day net inflow of HKD 29.6 billion) and Wednesday (single-day net inflow of HKD 26.2 billion) both set new highs for single-day net inflows since the launch of the Shanghai-Shenzhen-Hong Kong Stock Connect.

Correspondingly, while foreign capital has flowed in this round, the scale is not large, and it remains dominated by passive and trading funds, with only a partial return of active funds (mainly from the Asia-Pacific region, but also with standard allocation or even slight over-allocation). This indicates that: on one hand, southbound funds may be one of the main forces in this round, while on the other hand, it also shows that southbound funds cannot exert absolute "pricing power." Therefore, reviewing the historical instances of significant southbound inflows and their impacts, and estimating future inflow space and "pricing power" becomes an important reference for judging the sustainability of this market rebound. We will provide a detailed analysis in this article.

I. What are the characteristics of this round of southbound inflows? Large scale and fast speed, possibly the main force; active participation from individuals and private equity, with insurance public funds also continuing to allocate; high dividends shifting towards technology stocks.

This round of southbound inflows began in October last year and accelerated after the Spring Festival, showing a phenomenon of large scale and fast speed. In November, January, and February, the average daily net inflow exceeded HKD 5 billion, and since the beginning of this year, there have been 10 trading days out of 27 where the single-day net inflow exceeded HKD 10 billion. For the entire year of 2024, southbound funds are expected to flow in HKD 807.87 billion, averaging HKD 3.47 billion per day; since the beginning of this year, southbound funds have cumulatively flowed in HKD 375.53 billion, averaging HKD 8.16 billion per day, more than double that of last year. Thanks to the rapid and significant inflow of southbound funds, the proportion of southbound trading volume in the Hong Kong Stock Exchange's main board trading volume once climbed to 33.7%, and the market value of southbound holdings accounted for 10.5% of the total market value of the Hong Kong main board, both setting historical highsAt the same time, the AH premium once narrowed to a recent low of 130.5%.

From the background, the narrative of technology stocks and the revaluation of Chinese assets triggered by DeepSeek after the Spring Festival is the main catalyst driving the recent inflow of southbound funds, especially more evident in the past two weeks. Previously, when the market had just broken through the previous market peak in early October, some investors had even seen outflows due to loss recovery (《再论中国资产的重估前景》).

Meanwhile, EPFR shows that although foreign capital has slightly returned to the Chinese market overall, the scale and speed are significantly lower than last year's "924" market, mainly consisting of passive and trading funds, while active funds are still flowing out overall (《资金的 “东升西落”？》). According to our communication with overseas clients, the inflow of some LO active funds is still mainly from the Asia-Pacific and emerging market regions, and it is highly likely that they are already standard or even overweight, but are temporarily unwilling to significantly increase positions at the current level; while there has been no obvious return of funds from Europe and the United States. Therefore, the sources of incremental funds in the future will come from long-term funds in Europe and the United States, and southbound funds.

Chart 2: Active foreign capital is still flowing out overall, while passive foreign capital is slightly returning Source: FactSet, Bloomberg, CICC Research Department

From the source, the continuous inflow of southbound funds may come from the activity of individuals and private equity, as well as the continuous allocation by public funds and insurance capital. Since the composition details of southbound funds have not been disclosed, it is difficult for us to obtain a complete picture. However, based on various information, we find: 1) Recently, the net inflow of mainland investable Hong Kong stock ETFs has rapidly increased, reaching a monthly high, which may mainly come from individual investors; 2) Recently, some small and medium-sized stocks in the Hong Kong Stock Connect have shown abnormal fluctuations, similar to the performance characteristics of some small and medium-sized stocks in A-shares, indicating that there may be speculation and private equity participation, including funds that previously invested in U.S. stocks quickly switching to Hong Kong stocks under the "东升西落" narrative; 3) Some insurance capital is still continuously allocating high-dividend Hong Kong stocks and slightly increasing allocation to the technology sector; 4) Mainland public funds have also significantly increased their allocation to Hong Kong technology stocks.

Chart 3: The monthly net inflow of investable Hong Kong stock ETFs has reached a historical high recently, with individual investors likely being the main force Source: FactSet, Bloomberg, CICC Research DepartmentFrom the perspective of capital flow, there is a gradual shift from high dividends to technology. At the end of last year, high dividends were still one of the main directions for southbound capital allocation, but since February, southbound capital inflows have begun to focus heavily on technology stocks. Since the Spring Festival, southbound capital has increased its holdings in the top ten stocks by a total of HKD 133.09 billion, accounting for 55% of the overall southbound inflow, with Alibaba alone receiving a net inflow of HKD 73.46 billion, accounting for 31% of all inflows. From the distribution of the top ten stocks, apart from the dividend sector that has always been favored by southbound capital (accounting for 15% of all inflows), technology stocks have become the focus of this round of investment (Alibaba, Kuaishou, Li Auto, Tencent, and XPeng have collectively received 40% of the overall inflow).

Chart 4: High dividends and technology stocks have been the main sectors for southbound capital increases since the beginning of the year Note: As of March 14, 2025. Source: Wind, CICC Research Department

II. What are the circumstances of previous large southbound inflows? They often occur during periods of high market sentiment, and the flow direction depends on the market environment.

We have sorted out three time periods of accelerated inflows since the launch of the Shanghai-Hong Kong Stock Connect, and found that the accelerated influx of southbound capital often occurs during periods of high market sentiment, which is related to the trend-following trading characteristics of southbound capital, even "chasing highs and cutting losses." Therefore, short-term inflow peaks often correspond to the cyclical peaks of the market. In terms of flow direction, each round of southbound capital inflow is more related to the current market environment, such as core assets or high-dividend stocks that have a valuation advantage compared to A-shares, or new economy and internet sectors that are lacking in A-shares.

Chart 5: Monthly average net purchases of southbound Shanghai-Hong Kong Stock Connect Source: FactSet, Bloomberg, CICC Research Department

From the end of 2014 to the beginning of 2015: The launch of the Stock Connect, and the surge in the ChiNext stimulates southbound catch-up trading.

► Background: 1) The Stock Connect officially launched: In November 2014, the Stock Connect officially launched, allowing mainland investors to directly invest in Hong Kong stocks through the Stock Connect, effectively opening up the channel for southbound capital inflows. 2) The surge in the ChiNext stimulates southbound catch-up trading: From the second half of 2014 to June 2015, A-shares experienced a leveraged bull market, with the Shanghai Composite Index soaring from 2000 points to over 5000 points, and the AH premium rapidly rising from 101 in November 2014 to a mid-2015 peak of 130At the same time, Hong Kong stock valuations remain at a relatively low level, with the Hang Seng Index's dynamic valuation still around 10x in November 2014; 3) Policy dividends catalyze state-owned enterprise concepts: In March 2015, the government work report emphasized deepening state-owned asset and enterprise reform, leading to a surge in capital for Chinese central enterprises listed in Hong Kong.

► Structural characteristics: According to the disclosure of the top ten active stocks under the Stock Connect, several stocks that saw the most inflow during this period, such as Hanergy Thin Film Power Group, Haitong Securities, and Golden Eagle Commercial Group, have now been delisted. In addition, stocks like China Minsheng Bank, CNOOC Services, CITIC Bank, and Zijin Mining also saw significant inflows.

► Subsequent inflows: After the peak inflow in April, the market peaked in May. In May 2015, the valuation bubble driven by the "leveraged bull market" quickly burst, and market sell-off sentiment spread to Hong Kong stocks. At the same time, expectations of interest rate hikes by the Federal Reserve rose, and the US dollar index climbed, which also suppressed market valuations.

From the end of 2017 to the beginning of 2018: Housing renovation drives a surge in domestic property stocks, and "asset scarcity" enhances the attractiveness of Hong Kong stock dividends

► Background: 1) The housing renovation real estate cycle drove a significant rise in domestic property stocks in Hong Kong in 2017; 2) "Asset scarcity" enhanced the attractiveness of dividend stocks in Hong Kong: The domestic financial deleveraging that began at the end of 2017 led to a contraction in non-standard assets, and insurance and bank wealth management funds urgently needed high-yield assets. High-dividend blue-chip stocks in Hong Kong met the "long-term holding + dividend-oriented" demand of insurance funds, becoming an alternative choice.

► Structural characteristics: Mainly high-dividend central state-owned enterprises. From September 2017 to February 2018, the top 15 stocks with the largest inflow of funds were basically high-dividend central state-owned enterprises, with a total inflow of HKD 33.12 billion, accounting for 13%. The top five were: China Merchants Bank, Zijin Mining, CITIC Bank, ASMPT, and Bank of China Hong Kong.

► Subsequent inflows: After the peak inflow in January, there was a pullback in February. Affected by concerns over interest rate hikes triggered by better-than-expected US non-farm payrolls, US stocks plummeted, dragging down Hong Kong stocks. At the same time, in January 2018, the US announced tariffs on imported photovoltaic products and washing machines, and market concerns over Sino-US trade frictions began to emerge.

From the end of 2020 to the beginning of 2021: Core asset market, return of Chinese concept stocks, and expansion of public offerings and pension funds

► Background: 1) Core asset market: In 2020, core assets in A-shares, such as consumer and pharmaceutical stocks (like Moutai and CATL), surged, with dynamic price-to-earnings ratios generally exceeding 50 times. Hong Kong stocks of similar types (such as Anta Sports and WuXi Biologics) offered better value, driving funds to "cut high and buy low." At the same time, the Hang Seng AH Premium Index remained above 140, with significant price differences in sectors like finance and energy. 2) Return of Chinese concept stocks and listing of technology leaders: Affected by US regulatory impacts on Chinese concept stocks, many Chinese concept stocks (such as NetEase, JD.com, and New Oriental) chose to list in Hong Kong for a second time in 2020, attracting mainland funds to chase technology assets. Meanwhile, the listing of Kuaishou in February 2021 also became a focal point for southbound fund buying. 3) Expansion of mainland public funds and increased allocation ratio of corporate pensions: In January 2021, the scale of newly issued funds exceeded 500 billion yuan, leading to a rise in demand for allocation of newly issued public fundsAt the same time, by the end of 2020, the asset allocation ratio of corporate annuity equity increased from 30% to 40%, and for the first time allowed annuity funds to invest in Hong Kong Stock Connect stocks, with an investment ratio not exceeding 20% of the net value of entrusted assets, boosting the demand for asset allocation in Hong Kong stocks.

► Structural characteristics: Highly concentrated in the top five leaders. In January-February 2021, there was a noticeable "head concentration" in capital inflows, with the top five stocks seeing a total inflow of HKD 268.4 billion, accounting for 86%. These stocks were Tencent, China Mobile, CNOOC, SMIC, and Meituan.

► Subsequent inflows: Overseas disturbances dragged down the Hong Kong stock market. Due to rising U.S. Treasury yields, increasing interest rate expectations, the "three red lines" in real estate, and policies related to education and the internet, the Hong Kong stock market began to retract in mid-February, and subsequently, southbound inflows also started to slow down. The increase in stamp duty in late February further intensified the outflow pressure.

In addition, in March 2020, mainland funds "bottom-fishing" also drove a wave of short-term large inflows of southbound funds.

► Background: 1) Valuation trough after a sharp decline: Affected by the rapid global spread of the pandemic, the Hang Seng Index fell 9.7% in a single month, with a dynamic PE reaching 8.7, a new low since 2011. 2) Defensive sectors and internet benefits: The economic recovery expectations brought about by the initial pandemic control made Chinese assets exhibit strong defensive properties, while the internet sector benefited from the rapid penetration of online scenarios during the pandemic. 3) Liquidity easing after central bank interest rate cuts: To counter the disturbances caused by the pandemic, the central bank released liquidity in March 2020 through reserve requirement ratio cuts and medium-term lending facility (MLF) operations.

► Structural characteristics: High dividends as the main focus, supplemented by internet leaders. In March 2020, southbound funds increased their holdings in the top five stocks with an inflow of HKD 71.31 billion, accounting for 51% of all southbound fund inflows that month, which were China Construction Bank, Tencent, Industrial and Commercial Bank of China, HSBC, and Agricultural Bank of China.

► Subsequent inflows: Increased risk appetite led to a slowdown in inflows. After April, market risk appetite rebounded, and funds gradually flowed out of defensive assets. At the same time, Chinese policies took effect, coupled with the rapid rise of the pandemic being controlled, enhancing the attractiveness of A-shares and diverting southbound allocation demand.

III. Does the southbound have "pricing power"? It has stage and local effects, but there is no "absolute pricing power."

From a long-term trend perspective, during the phase of significant inflows of southbound funds and focusing on certain stocks and sectors, there is indeed a phenomenon of "pricing power" continuously rising, typically seen in the high dividends of the past two years.

► Stage "pricing power" during rapid inflows of southbound funds. Since the opening of the Shanghai-Hong Kong Stock Connect in 2014, the continuous inflow of southbound funds has gradually increased the market capitalization and shareholding ratio of southbound transactions. From the subsequent impacts of each major inflow, each time corresponds to a significant increase in the transaction and shareholding ratios of Hong Kong Stock Connect: March 2015, January-February 2021, and the current market correspond to 30-day transaction ratios of 10%, 17%, and 30% of the Hong Kong Stock Exchange's main board; shareholding ratios of total market capitalization of 2.9%, 4.9%, and 10%, which has now reached a historical highChart 6: The proportion of Hong Kong Stock Connect holdings to total market capitalization reaches 10%, a record high Source: FactSet, Bloomberg, China International Capital Corporation Research Department

Chart 7: The increase in the proportion of southbound trading volume often corresponds to a narrowing of the AH premium Source: FactSet, Bloomberg, China International Capital Corporation Research Department

► The local "pricing power" of dividend stocks and small-cap stocks. We have compiled stocks with a southbound holding ratio of over 30%, finding that they are mainly small-cap stocks (market capitalization below HKD 5 billion) and dividend stocks. From the perspective of the holding structure of southbound funds in 2024, high-dividend targets account for 2/3 of the top 15 stocks with increased southbound holdings. This is also reflected in the AH premium, where the majority of companies listed in both markets are state-owned enterprises and traditional sectors, with financial, energy, telecommunications, and utilities sectors accounting for about 80% of market capitalization. Historically, every significant inflow of southbound funds has often corresponded to a rapid decline in the AH premium.

Chart 8: The A/H premium has fallen from 141% to 131% Source: FactSet, Bloomberg, China International Capital Corporation Research Department

Chart 9: Southbound pricing power is reflected in small-cap stocks and dividend stocks Note: As of March 14, 2025 Source: Wind, China International Capital Corporation Research DepartmentHowever, the aforementioned "pricing power" is ultimately temporary and localized. In the future, as southbound capital increases, it may be further strengthened, but in an open market like Hong Kong stocks, two factors determine that southbound capital cannot have "absolute pricing power."

► Short selling mechanism: The short selling mechanism allows overseas investors to sell securities by borrowing them from others, enabling them to sell without holding positions. Since 2000, the short selling ratio in the Hong Kong stock market has been gradually increasing, and during periods of significant market volatility, it has even exceeded 20%, often playing an important role in the short-term price movements. In contrast, southbound capital is currently unable to participate in short selling.

► Major shareholder placements: Since southbound capital cannot participate in private placements and allocations, coupled with the "lightning placement" mechanism in the Hong Kong stock market, southbound capital faces significant supply pressure in the short term. Unlike the lengthy review process for refinancing in the A-share market, the unique lightning placement model in the Hong Kong stock market allows listed companies to complete new share issuance or allocation of old shares within one day after a board decision. As of mid-March, we found that the total placement scale in the Hong Kong stock market has reached HKD 47.4 billion, exceeding half of the historical high in January 2021 (HKD 86 billion), which is noteworthy.

Chart 10: The total amount of placements in the Hong Kong stock market since March has reached HKD 47.4 billion, exceeding more than half of the historical peak in January 2021! Source: FactSet, Bloomberg, CICC Research Department

IV. How much space is left? Estimated at HKD 600-800 billion, with a holding ratio of 15%

Since the beginning of the year, southbound capital has accumulated inflows of HKD 375.53 billion, with an average daily inflow of HKD 8.16 billion, more than double the average daily inflow of HKD 3.47 billion in 2024. If this pace is linearly extrapolated, the total inflow for the year could reach HKD 1.8 to 2 trillion. So, how much space is left? We estimate the inflow space for various types of investors (insurance funds, public funds, private equity, and individuals) to be around HKD 600-800 billion. Specifically,

► Insurance funds: If the allocation of Hong Kong stocks increases to 20% of equity investments, the space would be around HKD 300-350 billion. According to the National Financial Regulatory Administration, as of the fourth quarter of 2024, the total investment of the insurance industry (including property and life insurance) in stocks and securities investment funds is RMB 4.1 trillion, accounting for 12.4% of its total fund utilization balance of RMB 33.3 trillion. Currently, the proportion of Hong Kong stocks in equity investments is about 15%. Assuming that the proportion of equity assets in insurance funds slightly increases to 15%, and the proportion of Hong Kong stocks rises to 20%, it could bring in an incremental capital of RMB 200-250 billionIn terms of new premiums, assuming the annual premium increase remains at RMB 3 trillion this year, with equity asset allocation at 15% and Hong Kong stocks accounting for 20%, it is expected to bring in an incremental fund of RMB 80-100 billion. The total of both amounts to approximately HKD 350 billion;

Chart 11: If the allocation of Hong Kong stocks in the equity investment portion increases to 20%, the space is about HKD 300-350 billion Source: FactSet, Bloomberg, CICC Research Department

► Private Equity Funds: If the allocation of Hong Kong stocks increases by 5%, the space is about HKD 150-200 billion. According to the China Securities Investment Fund Industry Association, as of the end of last December, there were 144,000 private equity funds in existence domestically, with a scale of RMB 19.9 trillion. Among them, there were 88,000 private securities investment funds, with a scale of RMB 5.2 trillion. Assuming the allocation ratio of Hong Kong stocks increases by 5% compared to the end of last year, it is expected to bring in HKD 150-200 billion;

► Actively Managed Equity Public Funds: If the allocation ratio of Hong Kong stocks rises to 40-45%, the space is about HKD 250 billion. As of the end of 2024, the quarterly report of public funds shows that there are a total of 2,083 actively managed equity funds in mainland China that can invest in Hong Kong stocks, with a Hong Kong stock holding of RMB 323.6 billion, accounting for 25.9% of the stock market value of RMB 1.25 trillion, the highest since 2020. The maximum investment ratio for fund names not including "Hong Kong stocks" cannot exceed 50%. Assuming the ratio rises to 40-45%, it is expected to bring in about HKD 250 billion in increments;

Chart 12: As of 4Q24, the holding of Hong Kong stocks accounts for 25.9% of the stock investment value of mainland actively managed equity funds that can invest in Hong Kong stocks Source: FactSet, Bloomberg, CICC Research Department

► Individual Investors (mainly in ETFs): If the allocation ratio of Hong Kong stocks also increases by 5%, the space is about HKD 250 billion. Recently, during the upward trend, the inflow of funds into ETFs investing in Hong Kong stocks has rapidly increased. Currently, among the 171 ETFs that can invest in Hong Kong stocks, the net inflow in the past month reached RMB 22.15 billion, setting a new monthly net inflow recordThe "China National Balance Sheet 1978-2022" released by the National Asset Liability Research Center of the Chinese Academy of Social Sciences in December 2024 shows that by the end of 2022, the total investment in stocks by the household sector was approximately 22.6 trillion RMB. Meanwhile, the 2024 "Shanghai Stock Exchange Statistical Yearbook" indicates that as of 2023, the proportion of individual investors with a total market value of holdings below 1 million RMB is 22.5%. Considering that there is still a capital threshold of 500,000 RMB to open Hong Kong Stock Connect trading permissions, these individual investors are likely to adopt more ETF allocations. Assuming the proportion increases by 5%, it is expected to bring in HKD 250 billion.

By summing the above four types of investors, we estimate that the inflow of southbound funds this year may reach HKD 950 billion to 1.1 trillion, and after deducting the HKD 375.5 billion that has already flowed in since the beginning of the year, the corresponding incremental space is about HKD 600 billion to 800 billion. Since the launch of the Hong Kong Stock Connect at the end of 2014, the cumulative inflow of southbound funds has approached HKD 4.1 trillion, with a market value of holdings close to HKD 4.5 trillion. If another HKD 800 billion flows in, the total scale of southbound funds will reach approximately HKD 5.3 trillion, accounting for about 15% of the total market value of all Hong Kong Stock Connect targets. However, apart from the relatively certain long-term stable inflow of insurance funds, the inflow and speed of other types of funds are greatly influenced by the market, and it is also difficult to assume the maximum allocation ratio, so the relatively certain incremental funds are around HKD 300 billion.

Further from a bottom-up perspective, 1) the attractiveness of dividend sectors to funds other than insurance capital is declining. Considering the Hong Kong stock dividend tax (20% for individual investors in H shares, up to 28% for red-chip stocks; corporate investors are exempt from tax if held for 12 months), when the AH premium converges to 125%, the dividend yield of Hong Kong stocks no longer has an advantage over A shares. In this round of market, the AH premium has fallen from 141% before the Spring Festival holiday to 130.5%. Currently, among stocks with a dividend yield above 4%, there are few with an AH premium above 125%. 2) In the technology sector, during this round of increase, the southbound inflow of the top five stocks—Alibaba, Kuaishou, Li Auto, Tencent, and XPeng—accounted for 40% of the total. Their respective southbound holding ratios are currently 7.8%, 11.6%, 17.4%, 20.2%, and 17.3%. If we assume that the remaining stocks reach the same level as Xiaomi (20%), it corresponds to a technology stock-driven inflow of about HKD 730 billion. In the future, exemptions from dividend taxes, reductions in thresholds for individual investors, and the inclusion of more targets and products are expected to further increase the inflow of southbound funds.

Chart 13: Stocks with a dividend yield >5% have basically fallen below an AH premium of 125% Note: As of March 14, 2025, Source: Wind, CICC Research Department

Chart 14: If we assume that the remaining stocks reach the same level as Xiaomi (20%), it corresponds to approximately HKD 730 billion driven by technology stocks Note: As of March 14, 2025, Source: Wind, CICC Research Department

Authors of this article: Liu Gang, Wu Wei, et al., Source: CICC Insights, Original Title: "CICC: How Much Space is Left for Southbound Inflows?"

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