Source: Securities Times
Author: Chen Jiahe

Since the beginning of this year, the Hang Seng Stock Connect China AH Premium Index has seen a significant decline compared to last year. As of this Friday, $Hang Seng Stock Connect China AH Premium Index (800911.HK)$ the point has dropped by 9 percentage points compared to the end of 2024.

This Index is crucial for investors who pay attention to both A-shares and H-shares investment opportunities. The Hang Seng Stock Connect China AH Premium Index calculates the premium rate of A-share Stocks relative to H-share Stocks. When this index is greater than 100, it can be considered that on average, A-share Stocks are more expensive than their Hong Kong-listed counterpart H-share Stocks, and vice versa.

When an investor holds a Stock that is listed on both A-shares and H-shares, they can observe the changes in the Hang Seng Stock Connect China AH Premium Index to Trade back and forth between the two markets, thus continuously gaining arbitrage profits.

However, the aforementioned analysis is relatively simple and based on principles. In reality, the actual application of the Hang Seng Stock Connect China AH Premium Index is much more complex.

First, the weight of the Hang Seng Stock Connect China AH Premium Index is more inclined towards Market Cap weighting, rather than the arithmetic average premium rates of each Stock. This means that if large companies have lower AH Stock premium rates and small companies have higher AH Stock premium rates, the Hang Seng Stock Connect China AH Premium Index will be relatively lower; conversely, if large companies' premium rates are higher and small companies' are lower, the index will be relatively higher.

Therefore, we can see that investors cannot simply judge whether their Stocks are better in A Shares or H Shares based solely on the high or low of the Hang Seng Stock Connect China AH Premium Index.

For example, we often see that when the Hang Seng Stock Connect China AH Premium Index is at 100 points, a small company's A Shares may be three times more expensive than its H Shares. At this time, from a value perspective, even though the Hang Seng Stock Connect China AH Premium Index is at 100 points, clearly the A Shares have a significant advantage for that specific company.

Secondly, although the stocks are equal in rights, the values of A Shares and H Shares are not naturally completely equal.

This inequality primarily comes from two aspects: taxes and liquidity. From a taxation perspective, for different investors, the dividend tax, transaction tax, capital gains tax, and corporate income tax differ between A Shares and H Shares. Overall, the tax rates on A Shares are generally lower. Therefore, if the prices of A Shares and H Shares are exactly the same, it is clear that A Shares have greater value.

From the perspective of liquidity, due to backing from the mainland economy, the liquidity of A Shares is generally higher than that of H Shares in most cases. Even though when foreign capital surges into Hong Kong (for example, in the first two or three months of 2025), the liquidity of H Shares can temporarily surpass that of A Shares, this transient phenomenon does not change the overall pattern.

Moreover, we need to note that although both are money, the liquidity of A Shares is not the same as that of H Shares.

Due to the different composition of investors, the liquidity of A Shares is often more impulsive and less accurate in pricing, while the liquidity of H Shares is relatively more rational (note: this is merely a "relative" concept).

Therefore, under similar volumes, the liquidity of AH Stocks more easily causes price mismatches between Stocks, providing investors with more opportunities to Buy low and sell high. Hence, even in cases of similar volumes, the liquidity of AH Stocks delivers greater value to investors compared to the liquidity of stocks listed in Hong Kong.

Moreover, regarding the fluctuations in the Hang Seng Stock Connect China AH Premium Index, it is important to note that although this Index indicates the relative price levels of AH Stocks and Stocks listed in Hong Kong, seemingly reflecting the strengths and weaknesses of value, this value does not necessarily translate into tangible profits for investors in terms of price or Market Cap.

This transmission of value towards price faces at least two types of obstacles.

The first obstacle comes from time. It is well known that once we make valuable trades in the Capital Markets that increase value, this value will not immediately reflect in the price, which may take several years.

For investors, whether their funds can withstand such a long Range of value realization that could stretch over several years is something to be carefully considered.

For instance, the Hang Seng AH Premium surged by 37% in 2014, rising from 94 points at the end of 2013 to 129 points. Theoretically, with the establishment of the Stock Connect trading system at the end of 2014, this significant increase in the premium rate should rapidly adjust back as trading channels opened.

However, the time for the market to regain rationality often takes longer than people expect (this is also why many value investing gurus advise against shorting Stocks). In 2015, the Hang Seng AH Premium Index continued to increase by 8%. Furthermore, by 2025, despite the Stock Connect trading mechanism operating smoothly, the Hang Seng AH Premium Index had not returned to the 94 points of 2013 even after more than ten years.

The second obstacle arises from the risk of Stocks being Delisted. When a company's A-share price is significantly higher than its H-share price, if investors directly sell the A-shares and buy H-shares, although the value may increase substantially at that moment, a traditional concern exists in the Hong Kong market about major shareholders privatizing undervalued listed companies and then Delisting them. Therefore, if the valuation of the Hong Kong stocks becomes too low, leading to privatization and Delisting, even though there may be some premium provided upon privatization, if the gap between price and value is too large, much of the value increase earned by investors in trading may forever remain unrealized into tangible profits.

It can be seen that when investors understand the Hang Seng Stock Connect China AH Premium Index and the price differences between AH Stocks and Stocks it represents, they must consider many aspects instead of simply identifying a trading opportunity that could increase value and assuming it will guarantee a profit.

When facing different prices for the same AH Stocks and Stocks, we need to thoroughly consider factors such as the current and historical premium rate of individual Stocks, the probability of privatization for Hong Kong Stocks (possibly considering the privatization probability for AH Stocks in the future), the proportion of Stocks in the investment portfolio and the bearable risk of privatization and (Delisted), the time period that the Account funds can endure, and trends in liquidity and tax changes across the strait, before making appropriate investment decisions.

Editor/rice