A reversal? Will H shares be more expensive than A shares?

Multiple factors drive A/H premium to a five-year low.

On March 20, James Wang, Tommy Tang, and others from UBS China's equity team released a research report stating that the A/H premium in China has decreased by about 20% over the past three months, approaching a five-year low. This trend is influenced by multiple factors, including the AI-driven rise of H-shares, limited inflow of A-share funds, and the easing of China-U.S. relations.

The report indicates that based on historical data and market analysis, now may be a good time to allocate to dual-listed companies' A-shares, especially those with A/H premiums at historical lows.

Four Key Drivers Behind the Narrowing A/H Premium

The report analyzes four key factors leading to the narrowing of the A/H premium.

First is the AI boom favoring H-shares. The report states that the market frenzy triggered by DeepSeek has allowed H-shares to gain more returns. Due to the relatively lower valuation of H-shares compared to A-shares, this wave of artificial intelligence enthusiasm has provided greater upside potential for H-shares, compressing the premium level between A and H shares.

Market data shows that the gains in AI-related sectors in the H-share market are significantly higher than those in the A-share market, leading to a reduction in the relative valuation gap between the two markets.

Second, the pace of China's economic recovery is moderate, and market expectations for policy are relatively low.

Third, the flow of domestic funds is limited. The report shows that inflows into mutual funds in the A-share market are limited, affecting the overall performance of A-shares. In contrast, the Hong Kong stock market continues to see inflows from southbound funds, with records indicating that the net inflow of southbound funds as a proportion of the total market capitalization of Hong Kong stocks is continuously rising.

Lastly, the easing of China-U.S. relations. The report states that geopolitical risks play an important role in the A/H premium. Currently, the market seems to have digested most geopolitical concerns, with the market's "geopolitical fear index" at a relatively low level, indicating that the market expects no sharp deterioration in China-U.S. relations.

Historically, when geopolitical risks increase, A-shares tend to be more resilient than H-shares due to the lower participation of international investors in A-shares.

Long-term View: A/H Premium May Remain Below Historical Levels

The report states that in the long term, due to the increasing share of southbound funds in the Hong Kong market (currently reaching 11.2% based on share count, comparable to the level of foreign active funds), the normalized A/H premium may continue to remain below historical levels.

The report also adds that due to liquidity differences between A and H shares, as well as entry barriers for H-shares, a certain degree of permanent A/H premium still exists.

The report further finds that cyclical industries (such as liquor and consumer finance) often perform well in the month before the A/H premium expands. Currently, the liquor and catering sectors have begun to perform well, which may indicate that the premium could soon reverse.**

Focus on Dual-Listed Companies with Low A/H Premiums

UBS stated that as the A/H premium approaches historical lows, domestic mutual funds' holdings in Hong Kong stocks are at historical highs, coupled with signs of improvement in the macro economy, the A/H premium may rebound.

The report also provides a list of large-cap dual-listed companies with A/H premiums at historical lows as potential targets for A/H premium reversal.

The report specifically mentioned China Telecom, Chongqing Rural Commercial Bank, and China Coal Energy, all of which have A/H stock premiums at historical lows. Additionally, the A/H premiums of companies such as China Merchants Bank, BYD, WuXi AppTec, and Midea Group are also at relatively low levels.

1. A-shares lack short-selling mechanisms