Southbound flows:How much,how sustainable,and how to play?

One of the Connect bright spots.

Southbound (net) flows have exceeded US$7bn ytd, outpacing ETF and active flowsof US$1.6bn and -US$1.0bn respectively, and becoming the most importance sourceof capital inflows to the HK market. We address three key ‘Hows’ in this piece.

How much?

We estimate net Southbound flows to reach US$54bn/US$51bn in 17/18(US$32bn in 16) based on our top-down model and cross-industry comparison. By2018, we expect Southbound ownership in HK stocks to rise to 5.1% from 1.3% atpresent, and turnover to account for 8.4% of HKEx’s trading from 4.3% now.

How sustainable?

Rmb weakness aside, we see the asymmetry between China’s capital base(US$19tn) and HK’s market depth (US$2.1tn free-float cap), broadening ofinstitutional investor pool (mutual funds, insurers, pension fund), and sustaineddemand for outbound portfolio investment/diversification underpinning the longevityof Southbound flows, and channeling sticky, and fundamental-driven capital to HK.

How to play?

Conventional wisdom hasn’t been very effective in predicting flow recipients, andflows haven’t always translated into alpha, underscoring the practical merits offocusing on our Select “Southbound favorites” which boast high Southboundownership and participation, and with solid fundamental support.