Overall trend: There is active holdings reduction. The allocation ratio is the lowest since 2017, and the US institutional allocation ratio is the lowest since 2015

Overseas asset management institutions have taken the initiative to reduce their holdings, and the allocation ratio for Chinese stocks is low since 2017. 1) The market value of Chinese stocks held by overseas asset management institutions (active+passive) in the third quarter was US$670.1 billion, a decrease of US$27 billion (-3.9%) from the second quarter, greater than the 3.1% decline in the MSCI China Index during the same period. 2) The market value of Chinese stocks held by active institutions fell 4.8% to 489.1 billion US dollars (vs. 513.7 billion US dollars in the second quarter). The decline was greater than the decline in the index, indicating that there was active holdings reduction. 3) The holding ratio of Chinese stocks in the third quarter (Chinese stocks/total assets) was 1.6%, flat in the second quarter and still the lowest since 2017.

Looking at the subregions, the size of Chinese stocks held by all regional institutions has declined; the US institutional allocation ratio is the lowest since 2015. Among all regions, the US, Hong Kong, China (excluding Chinese institutions), and the UK hold the largest shares of Chinese shares, accounting for 48%, 18%, and 18%, respectively. Compared with the second quarter, the market value of Chinese stocks held by US asset management institutions fell 3.4% to US$326 billion, accounting for 1.1% of holdings, which remained the same as in the second quarter, and still the lowest since 2015. Hong Kong, China (excluding Chinese institutions) declined by 5.4% to US$113 billion, but the holding ratio rose slightly from 40.7% to 41.2%, slightly higher than the average level of 40.6% since 2015. The UK fell 3.0% to US$124 billion, and its holdings rose slightly from 3.0% to 3.1% (historical average of 3.6%, lowest of 2.0%). Meanwhile, although the scale of holdings in Taiwan, Japan, Switzerland, and Australia is not high (the share varies from 1 to 3%), the decline in their holdings was even more obvious. In the third quarter, they fell by 8.8%, 6.8%, 6.0%, and 5.6%, respectively.

Chart 1: The size of Chinese stocks held by foreign-funded management institutions fell back to US$670.1 billion in the third quarter, down 3.9% from the previous quarter

Chart 2: The size of Chinese stocks held by foreign-funded active management institutions fell back to 489.1 billion US dollars in the third quarter, down 4.8% from the previous quarter

Chart 3: A total of 2,236 foreign-funded management institutions allocated to the Chinese stock market in the third quarter, a slight decrease from 2,275 in the second quarter of this year

Chart 4: Foreign-funded management agencies allocated 1.6% of Chinese stocks in the third quarter, which is basically the same as in the second quarter

Chart 5: European and American asset management institutions' holdings in the third quarter increased compared to the second quarter, but Hong Kong, China declined significantly

Chart 6: The proportion of Chinese stocks allocated by US, Canadian, and Japanese asset management institutions in the third quarter was basically close to or at a new low since 2015

Chart 7: As of 3Q23, foreign asset management institutions in the US, Hong Kong, and the United Kingdom in major countries and regions held high volumes of Chinese stocks at 48%, 18%, and 18%, respectively

Chart 8: The size of Chinese stocks held by the top 20 foreign management agencies (parent companies) in the first half of the third quarter accounted for 61% of all foreign Chinese stock holdings, basically unchanged from the second quarter

Position structure: reduce holdings of A shares and China shares, increase holdings in Hong Kong stocks; reduce holdings in environmental protection, utilities, software, and increase holdings in automobiles, education, and hardware

Further focusing on the top 20 active management institutions holding Chinese stocks (accounting for 22% of the total size), these institutions held US$146.7 billion in Chinese stocks in the third quarter, down 4.8% from the second quarter. Further analysis of its position behavior made the following findings,

► Reduce holdings of A shares and China shares, but increase holdings of Hong Kong stocks. The market value of Hong Kong stocks held by the above institutions fell 4.4% month-on-month, and the Chinese stock market fell 3.5%, which is lower than the overall decline of 4.8%. In contrast, the 7.8% decline in A-share holdings was significantly higher, indicating that A-share holdings were actively reduced. After excluding price factors (constant price in 3Q23 × change in number of shares held), we estimate that the positions of the leading institutions mentioned above in A-shares decreased by 2.7% month-on-month, Hong Kong stocks increased by 0.8%, and China securities decreased by 2.9%. From the perspective of each market share, based on the constant price of 3Q23, Hong Kong stocks and A shares accounted for 57% and 30% of all Chinese shares held by foreign investors in the third quarter, respectively, which is still higher than the average value of 54% and 25% over the past 3 years, while the Chinese stock market is 14%, which is clearly below the average value of 20%.

► Industry preferences: reduce holdings in environmental protection and office services, utilities, software, etc.; add stocks of automobiles, education, hardware, etc. Excluding price factors, we estimate that leading asset management institutions reduced their holdings the most in commercial and professional services (mainly related to environmental protection, office services, etc., -16%), utilities (-8%), software and services (-6%), real estate (-5%), financial services (+6%), automobiles and parts (+4%), consumer services (mainly education, etc., +3%), and technical hardware (+2%). Looking at the level of allocation, foreign ownership of media and entertainment (19%), e-commerce retail (10%), consumer services (10%), and food and beverage (7%) remains the most; telecommunications services (0.1%), commercial and professional services (0.4%), and household and personal goods (0.5%) are the lowest.

► Heavy stocks: The new heavy stocks were mainly focused on education and hardware; software and photovoltaics were transferred out. The top 20 heavyweight stocks had a total of 107 stocks, a decrease of 8 from 2Q23. Specifically, there are 7 individual stocks that have entered the top 20 heavyweight stocks, mostly in the fields of education and hardware, respectively$NEW ORIENTAL (EDU.US) $, Zhonghai Oilfield,$Wanhua Chemical (600309.SH) $,$IFF (601138.SH) $,$Oriental Selection (01797.HK) $,$Tiger Pharmaceuticals (03347.HK) $versus$Zhuo Shengwei (300782.SZ) $。 In contrast, 20 individual stocks were excluded from the top 20 heavy-held stocks, namely China Resources Vientiane,$Top Group (601689.SH) $,$Baoxin Software (600845.SH) $,$Golden Butterfly International (00268.HK) $,$Postbank (01658.HK) $,$Tsingtao Brewery (600600.SH) $,$Xinyi Light Energy (00968.HK) $,$Longji Green Energy (601012.SH) $,$Hanson Pharmaceuticals (03692.HK) $,$ Zhongsheng Holdings (00881.HK) $,$China Railway (00390.HK) $,$China Micro Corporation (688012.SH) $,$Ziguang Shares (000938.SZ) $,$Reading Text Group (00772.HK) $,$User Network (600588.SH) $,$Hang Seng Electronics (600570.SH) $,$Convinced (300454.SZ) $,$Yifeng Pharmacy (603939.SH) $,$Polearia (603605.SH) $and$Chinese porcelain materials (300285.SZ) $, mostly in the software and photovoltaic sectors.

In terms of individual stocks, New Oriental,$China Taibao (02601.HK) $,$BYD (002594.SZ) $,$Baidu Group-SW (09888.HK) $,$Shenzhou International (02313.HK) $,$Ningde Era (300750.SZ) $,$Medicated Kangde (02359.HK) $Wait for the biggest increase in holdings;$Chinese Ping An (02318.HK) $,$Postbank (01658.HK) $,$NetEase (NTES.US) $,$ China Merchants Bank (03968.HK) $,$ Yum China (YUMC.US) $,$Jingdong Group (09618.HK) $,$Changjiang Electric Power (600900.SH) $,$Kweichow Moutai (600519.SH) $Waiting to reduce holdings the most.

Chart 9: In the third quarter, the holdings of leading foreign investors in A-shares decreased by 2.7% month-on-month, Hong Kong stocks increased by 0.8%, and Chinese securities decreased by 2.9%

Chart 10: In terms of allocation ratio, Hong Kong stocks and A shares accounted for 57% and 30% of the total Chinese stocks held by foreign investors in the third quarter, respectively

Chart 11: Foreign investment in the third quarter mainly reduced holdings in utilities, real estate, essential consumption, etc., and increased holdings on optional consumption and raw materials

Chart 12: In terms of industry segments, holdings in commercial services, software, real estate, etc. were mainly reduced, and stocks of automobiles, consumer services, technology and hardware were added, etc.

Chart 13: The allocation ratio of foreign investment in the optional consumption and communication services sector was high in the third quarter

Chart 14: Further segmentation, media and entertainment, e-commerce retail, consumer services, and food and beverage are the highest

Chart 15: The situation of leading active foreign management institutions with heavy holdings in Chinese stocks in 3Q23

Chart 16: The situation of leading active foreign management institutions with heavy holdings in Chinese stocks in 2Q23

Chart 17: Excluding changes in stock price factors, leading active foreign investment management agencies added or reduced allocations to individual stocks in 3Q23

Prospects: Foreign capital is already underallocated, but whether it can flow back still requires a recovery in fundamentals, and the central government's increased leverage as a starting point

Since the third quarter, as domestic growth and policy expectations have weakened again, overseas capital outflows have accelerated. Overseas active funds under the EPFR caliber have had a cumulative outflow of US$12.7 billion from Chinese stocks (A shares+Hong Kong stocks+ADR) since the third quarter, which is significantly higher than the size of the outflow of US$4.5 billion in the second quarter; the large outflow of northbound capital that began in August also confirms this (cumulative outflow of 129 billion yuan from the third quarter to date).

Currently, according to EPFR statistics, the world's major regional funds have all declined to low allocations to Chinese stocks, such as Asian (excluding Japan) funds with low allocations in China -2.3% (46.5% quartiles for the past 10 years), emerging market funds underallocation -2.9% (at 61.2% quartile), global (excluding US) funds underallocation -1.9% (3.1% quantile), and global funds underallocation -0.3% (1.5%); this is consistent with our trend of changes in the allocation of Chinese stocks calculated from the bottom up.

Looking ahead, whether foreign capital can return requires an improvement in the market and fundamentals as a prerequisite. Simply low allocations and the Fed's cessation of interest rate hikes are not sufficient conditions. We are in”How to portray and analyze foreign investment?” Foreign capital is divided into three categories: transaction type (5%), sovereignty type (10 ~ 20%), and value type (60 ~ 80%) type. Among them, value capital, which dominates and is more dominated by fundamental factors, determines the reality that overall foreign investment basically determines the flow of foreign capital, which is often a lagging indicator of market performance and fundamentals.

Economic data for October generally weakened, indicating that policy support is still necessary. Considering that other private sectors are unable or willing to increase leverage, the key to driving growth is to rely on fiscal strength to push the credit cycle to start. In other words, the increase in leverage from the central government represented by the increase in treasury bonds in November is in the “symptomatic” direction, but speed and magnitude are just as important. We estimate that an increase in the fiscal deficit of about 6 trillion yuan is expected to raise the fiscal pulse to a record high of 4 ppt in the first half of next year. If it expands by about 3 trillion yuan, then the corresponding fiscal pulse will be corrected in the middle of next year and will not contract. Based on this consideration, we recommend that investors pay attention to the signals of the Federal Reserve FOMC meeting on December 14, the Central Economic Work Conference held at the end of the year, and the Politburo meeting on growth and policy. At the same time, whether the monthly fiscal expenditure situation and the LPR interest rate on December 20 are adjusted can also be used as an important verification window to observe policy signals and become the key to market trends.

Chart 18: Since mid-March, the total outflow of overseas active capital from A-shares has been 5.3 billion US dollars, exceeding the outflow of 2 billion US dollars for the whole of last year

Chart 19: Since mid-March, the total outflow of overseas active capital from overseas Chinese stocks has been 11.9 billion US dollars, close to the outflow scale of 13.7 billion US dollars for the full year of last year

Chart 20: Currently, the allocation ratio of funds in major regions around the world to Chinese stocks is under-allocated

Chart 21: Value capital (mainly mutual funds, accounting for 60 to 80%) that dominates the low level of foreign investment is mainly dominated by domestic fundamentals

Chart 22: Fiscal impulses measured by different calibers have all fallen into a negative range since this year, and fiscal stimulus has weakened compared to last year

Chart 23: The leverage ratio of the central government is about 22%. From the perspective of international comparison, there is still room for additional leverage

Chart 24: “Dumbbell” allocation strategy for Hong Kong stocks

Chart 25: Hong Kong Stock Market “Mid-tier Overseas” vs. “High-End Upgrades”

Chart 26: Automobiles (including new energy), software and services, media and entertainment, semiconductors, etc. are sensitive to economic cycles and monetary policies

Chart 27: Two rounds of rebound in industry growth at the beginning of 2019 and end of 2022

Editor/Jeffrey