Hong Kong stock market IPOs explode! Annual return rate of 18% outperforms Hang Seng Index. Foreign investors rush to acquire Chinese core assets.

This year, the Hong Kong IPO market has recovered, with a total financing amount of $9 billion from the beginning of the year to date, although still below the peak of 2020, it has grown by 320% year-on-year. The average return rate of IPOs from the beginning of the year is 18%, outperforming the Hang Seng Index (+13%); in contrast, the average return rate of IPOs in the past few years after three months was only 4%. UBS believes that this outstanding performance reflects several factors, including: 1) the improvement in the quality and vintage of listed companies; 2) tightening IPO restrictions in mainland China; 3) improvement in Hong Kong liquidity; 4) increased demand from foreign investors for core Chinese assets. These new listed companies in turn further diversify and strengthen the industry composition of H-shares, and with temporary easing of tariffs, low foreign investor holdings, and lower valuations of the Chinese stock market compared to other markets, UBS continues to hold a positive view on H-shares. 1. Short-term A-H premium may narrow The current A-H premium is 33%, close to the 10-year average level, but lower than the recent 5-year average level. UBS believes that there is room for the short-term A-H premium to narrow, reasons include: 1) easing of geopolitical tensions after tariff relief; 2) if Deepseek launches an updated model, it may rekindle optimism for artificial intelligence; 3) Chinese artificial intelligence stocks trade at a discount compared to their US counterparts; 4) improved liquidity in Hong Kong; 5) increased foreign inflows, which will favor the Hong Kong stock market as A-shares only make up 13% of the MSCI China Index. Although overall the A-H premium will exist, historically, certain stocks have shown A-H discounts (rather than premiums): 1) they are seen as core holdings by foreign investors; 2) Hong Kong liquidity is higher than A-shares. These stocks include BYD Company Limited and China Merchants Bank, with potential A-H discounts of up to 12%, although currently, these stocks have an A-H discount of about 3%. 2. Passive capital flows may also boost large IPOs in Hong Kong Blue-chip A-share companies listed in Hong Kong may further benefit from passive capital inflows. UBS notes that, for example, the MSCI China Index does not adopt market-based reductions for stocks listed in Hong Kong (next rebalancing announcement date is August 7 of the following year), while the Hang Seng Tech Index (HSTECH) favors high-tech companies in its constituents (quarterly rebalancing). UBS estimates that the management funds of Exchange-Traded Funds (ETFs) tracking the Hang Seng Tech Index and the MSCI China Index are approximately $24 billion and $12 billion, respectively. 3. Inflow of Southbound funds still far exceeds financing amount Despite the frequent IPO activities this year, the total financing amount is still relatively small compared to the peak in 2020 and the Southbound fund inflow of $53 billion from the beginning of the year to date. In addition, with the influx of A-share blue-chip companies and the return of American Depositary Receipt (ADR) names, the diversification and quality of Hong Kong stocks have improved. Considering the steady profit performance of H-shares so far (Hang Seng H-Share Index ETF index Q1 2025 profit increased by 7% year-on-year, Hang Seng Tech Index component stocks increased by 38%) and the over-allocation of AI-related stocks, UBS continues to be bullish on H-shares rather than A-shares.