Zhongjin: Cumulative inflows from the South may exceed one trillion Hong Kong dollars within the year.

Since the beginning of this year, the Hong Kong stock market has been continuously active with highly structured industry rotation, closely related to the exceptionally abundant liquidity. In our previous report, we analyzed in detail the composition and evolution of the funding situation in the Hong Kong stock market. Among the major forces affecting the funding situation in the Hong Kong stock market: in addition to the unexpected injection of a large amount of funds by the Hong Kong Monetary Authority in May to July resulting in extremely abundant micro liquidity in the Hong Kong stock market, the Southbound funds played a key, even decisive role, while overseas funds did not see a significant outflow and even decreased compared to the allocation at the end of March. Looking ahead, considering that the Hong Kong Monetary Authority needs to continuously withdraw funds to defend the weak side of the Hong Kong dollar, the US Treasury will face pressure to supply $1 trillion in bonds in the third quarter, the Southbound funds will play a more important role. Evidence is as follows: 1) the proportion of Southbound funds trading volume has further increased to a high of 35%; 2) Based on data and survey results, foreign funds not only did not significantly increase their allocation, but the proportion of underweight has actually increased. Since the beginning of this year, the net inflow of Southbound funds has reached HK$797.45 billion, which is close to the total inflow of HK$807.87 billion for the whole of last year. Among the Southbound funds, according to the trading characteristics reflected by the fund attributes, 1) the proportion of actively managed mutual funds' Hong Kong stock holdings has increased from 25.8% at the end of last year to 32.5% currently. The total size of these funds is approximately HK$1.55 trillion, with an increase in Hong Kong stock allocation of approximately HK$100-120 billion since the beginning of the year. However, considering the index price factor (average increase of about 15%), the net increase in Hong Kong stocks for these funds is about HK$85-105 billion so far this year, contributing to around 10-15% of the net inflow of approximately HK$800 billion from the South since the beginning of the year; 2) The overall Hong Kong stock holdings of mutual funds have increased from 30.5% at the end of last year to around 39.8% currently. The total size of these funds is approximately HK$2.62 trillion, with an increase in Hong Kong stock allocation of approximately HK$250-300 billion since the beginning of the year. Similarly, considering the price factor, the net increase in Hong Kong stocks since the beginning of the year is approximately HK$220-280 billion. Excluding actively managed mutual funds, the net increase in Hong Kong stocks for these funds (mostly ETFs) is about HK$150-200 billion, contributing to around 25-30% of the Southbound funds. The remaining approximately 50% is relatively difficult to break down, with more of it being steadily bought by insurance companies, especially in dividends, particularly in banks. Since the beginning of the year, we have also seen that the premium of AH shares in the Hong Kong stock banking sector has fallen below the theoretical "invisible floor" of 125% (contributing approximately 25-35%); while the remaining 15-20% belongs to individual investors and private equity funds trading directly through the Stock Connect system. Combining the latest disclosures of mutual funds in the second quarter, we have updated the Hong Kong stock holdings and allocations of mutual funds to provide more details on the trends of the Southbound funds. Overall trend: Active equity Hong Kong stock positions have risen to 32.5%, but the proportion in the Southbound funds continues to decline, indicating that actively managed mutual funds are not the main players. Firstly, looking at the total size, the overall size of investable Hong Kong stock mutual funds has risen, with new funds accelerating as well. As of the end of the second quarter, there were a total of 4,048 Mainland investable Hong Kong stock mutual funds (excluding QDII), with total assets of RMB 2.62 trillion, an increase of 152 funds and RMB 153.2 billion in size from the first quarter. Among them, 1) there were 2,200 actively managed equity funds (total size of RMB 1.56 trillion, excluding ETFs), with an increase of RMB 32.6 billion in size. 2) The size of investable Hong Kong stock ETFs has grown even faster, with a size of RMB 380.93 billion at the end of the second quarter, up 16.7% from the end of the first quarter. In terms of issuance, the number of new investable Hong Kong stock mutual funds accelerated significantly in the second quarter compared to the first quarter, with an addition of 155 funds and a size increase of approximately RMB 86.1 billion for the quarter (compared to 112 funds and RMB 71.6 billion for the first quarter). Active equity funds also followed suit, with a faster pace of issuance than in the first quarter, totaling 65 funds, and an increase in size of RMB 33.5 billion (compared to 43 funds and RMB 12.4 billion in the first quarter). Next, looking at the holdings, active fund Hong Kong stock positions have hit a new high, but their proportion in the Southbound funds continues to decline, indicating that actively managed mutual funds are not the main players in the Southbound funds. The 4,048 mutual funds hold HK$734.3 billion of Hong Kong stocks, an increase of 12.8% from the first quarter's HK$650.9 billion. As of the end of the second quarter, the Hong Kong stock holdings of mutual funds accounted for 39.8% of their stock investment market value, up from 36.9% in the previous quarter, reaching a new high since the launch of the Shanghai-Hong Kong Stock Connect. By comparison, the Hong Kong stock holdings of actively managed equity funds in the Southbound funds have increased from 9.7% to 9.2%, indicating that actively managed equity funds are not the main players in the Southbound funds. In contrast, the market value of Hong Kong stocks held by passive ETFs increased by nearly 17% from HK$326.41 billion to HK$380.93 billion, with passive funds accounting for 5.6% to 6.2% of the Southbound funds, indicating a significant contribution from individuals and other institutional investors such as corporate pensions using ETF allocations. Industry allocation: Healthcare and finance are the most favored, while retail and media and entertainment have seen the most decline, with a decrease in stock concentration. Biopharmaceuticals, banks, and insurance have seen the biggest increase, while retail and media and entertainment have seen a noticeable decline. Compared to the first quarter, the Mainland mutual funds' share of Hong Kong stocks in old economy industries has increased from 20.7% to 22.9%, while the share of new economy industries has fallen for the first time since the first quarter of last year. In detail, the market value share of biotechnology, banks, and insurance sectors has increased the most. Conversely, the market value share of discretionary retail, media and entertainment, automotive and parts, and semiconductors has decreased the most. In terms of absolute holdings, the highest holdings are in media and entertainment, pharmaceuticals and biotechnology, and discretionary retail; while business and professional services, medical devices, and consumer essentials have lower holdings. In comparison to their historical levels, the banks and insurance sector are at historically high levels of allocation; in contrast, consumer services, energy, and real estate are at historically low levels. On a stock-specific level, the concentration of top holdings has significantly decreased; INNOVENT BIO (01801), 3SBIO (01530), and POP MART (09992) saw the most increase in holdings, while Alibaba (09988) and Tencent (00700) saw a significant decline. In the second quarter, Mainland mutual funds increased their holdings in pharmaceuticals and new consumer products, with INNOVENT BIO, 3SBIO, and POP MART increasing the most in terms of the number of funds holding shares and market value; on the other hand, Alibaba, Tencent, and Xiaopeng Motors (09868) saw the most decrease. In terms of top holdings, 3SBIO and Kuaishou (01024) replaced Ideal Automobile (02015) and CNOOC (00883) in the top ten holdings. Compared to the first quarter, the number of funds holding INNOVENT BIO, 3SBIO, POP MART, and CSPC Pharma (01093) saw the most increase, while the number of funds holding Alibaba, Tencent, and Xiaopeng Motors decreased significantly. Additionally, the concentration of top holdings has significantly decreased in the second quarter, with the top 3 holdings accounting for 30.9% of the market value of the top 100 holdings, down 8.9 percentage points from the first quarter, and the top 10 holdings accounting for 58.7% of the market value of the top 100 holdings. Outlook: The cumulative inflow of Southbound funds is expected to exceed HK$1 trillion this year; but it is better to buy at the bottom than to chase in times of frenzy, "New Dumbbell" allocation. On the funding side, the cumulative inflow of Southbound funds is expected to exceed HK$1 trillion, with a relatively certain increment of HK$200-300 billion. Since the beginning of the year, the cumulative inflow of Southbound funds has reached HK$797.45 billion, with an average daily inflow of HK$6.13 billion, approaching the total net inflow for the whole of last year (HK$807.87 billion in 2024, with an average daily inflow of HK$3.47 billion). If the current pace is maintained, the total for this year could be close to HK$1.5-1.6 trillion, which is quite challenging. In our reports released in mid-March and more recently, along with the latest data from mutual funds, it appears that institutions like mutual funds and insurance may not have as much firepower as initially thought. As of the second quarter, the Hong Kong stock holdings of actively managed equity funds had reached a historical high of 32.5%. Assuming the allocation increases to 40% (the highest investment proportion without "Hong Kong stocks" in the fund name should not exceed 50%), and considering the overall size of actively managed equity funds, and assuming the new fund issuance rate remains at the current level, there is expected to be an incremental space of approximately HK$120-150 billion. For the insurance segment, we have learned that insurance companies have increased their buying of Hong Kong bank stocks significantly since the beginning of the year, and the dividend tax in the Stock Connect system does not affect their investments. Assuming that the equity allocation rises to 15% and the Hong Kong stock allocation in the equity portion rises to 20%, taking into account the new premium portion, it is expected to bring in approximately HK$150-200 billion of incremental funds during the year. Therefore, we calculate that the relatively certain incremental Southbound funds during the year would be approximately HK$200-300 billion (about HK$100 billion from mutual funds and about HK$200 billion from insurance). As for the part involving individual investors and trading funds, the earning effect is crucial, leading to greater fluctuation in fund inflows and making it harder to calculate. Assuming that the above types of funds increase their current allocation in Hong Kong stocks by 2-3%, a rough estimate could also bring about an inflow of HK$50-100 billion. Market-wise, the recent upward breakthrough in the market towards the optimistic scenario we outlined in the previous report (Hang Seng Index reaching 26,000) has attracted widespread attention from investors. Is this breakthrough sustainable? In other words, as the market rises, should you increase your positions or gradually take profits? Our view is as follows: 1) The factors driving this round of uptrend are two-fold: firstly, the internet sector, which has been underperforming since April (benefiting from the boost provided by the H20 chip and the cooling of the takeaway battle), has resulted in the recent performance of the Hang Seng Index being stronger than the Hang Seng Tech Index (the "tech content" of the Hang Seng Index is 40%); secondly, the push of anti-inner circle policies and the Yajiang Hydropower Project have driven the cyclical goods, including construction, building materials, machinery, etc., resulting in the Hang Seng Index not lagging far behind. In comparison, the previously strong new consumption sector has seen a general pullback. 2) From the perspective of position and risk premium, the risk premium of the Hang Seng Index has fallen to 5.6%, lower than the levels at the beginning of March and the peak of the market last October. However, when broken down, the old economy (banks and cyclical sectors) has fallen significantly below the levels at the end of March, and even below the levels during the peak of the Chinese economy and real estate cycle in 2021, indicating a more frenzied sentiment in this part. The risk premiums of new consumption and innovative pharmaceutical sectors are also at low levels, which is consistent with the characteristics of the market rally since April. In contrast, the risk premium of the internet sector is still higher than the levels at the end of March. Therefore, if we assume that the risk premium of the internet sector falls back to the low point at the end of March this year, while the sentiment for new consumption/innovative pharmaceuticals and banks remains unchanged, this could drive the Hang Seng Index to around 26,000 points. 3) While the market rally appears strong, it is essentially a structural market: since the end of last year, the market has experienced three rounds of rebounds after the 924, AI, and tariff events, each led by different industry styles, which means that without accurately grasping the structural direction, such as having no internet holdings in the first quarter, all internet holdings in the second quarter, and still holding new consumption in the third quarter, it is impossible to achieve what seems like a strong increase in the index at the surface level. Therefore, while it may appear to be an index, the essence is still in the structure. 4) How sustainable is the market rally? We must acknowledge that a market rally driven by liquidity and sentiment will always be higher than the levels calculated based on fundamentals, and pinpointing the levels driven by sentiment and liquidity is difficult. Policy and industry factors do have an effect, but more often than not, the "over-thinking" by the market in the beginning leads to an overextension: as with the anticipation of policy during 924; the "eastern rise and western decline" narrative discussed during the AI rally from January to March; and to some extent, the new consumption, innovative pharmaceuticals, and cyclical sectors observed since April. Essentially, there is not much difference. However, the advantage is that with ample liquidity and a supported bottom, these factors combined with the tendency for the market to overextend lead us to still believe that it is better to buy and prepare early during times of frenzy and chase, just as locking in some profits in frothy sectors at high levels can also help avoid losses, as was the case with the AI rally in March. The premise for the optimistic scenario we outlined earlier requires that the sentiment for banks and old economy sectors stays the same as the 2021 peak, while new consumption and innovative pharmaceuticals remain largely unchanged, and the internet sector returns to the sentiment at the beginning of March. 5) So how should one allocate? Starting from the perspective of "buying and preparing early during times of frenzy is better than chasing," we suggest that the overall allocation currently seems suitable: 1) On the dividend side, it may be advisable to shift moderately from the overextended bank portion to insurance; 2) On the growth side, it may be better to shift from the overextended new consumption sector to AI applications (gaming internet, short videos, software, etc.), Siasun Robot&Automation, and parts, while the short-term overextension in innovative pharmaceuticals remains valid, the so-called "new dumbbell" approach, with the core principle being to buy long-term correct sectors at reasonable levels. As for the cyclical sectors, the relatively lower capital structure and policy catalysts have brought about a significant trading market, but the sustainability requires observation: 1) the determination of policy in reducing excess capacity, 2) the importance of demand-side over supply-side, even in the 2015 supply-side reform, ultimately benefited from the significant leverage increase by the household sector due to the 2016 housing reform reversing the deflationary cycle. In the third quarter, attention needs to be paid to marginal tightening pressures on liquidity, including the Hong Kong Monetary Authority continuing to withdraw liquidity, tightening US dollar environment, and the potential supply pressure from IPOs/placements. At the same time, growth environment, policy progress, tariff negotiations, etc., should also be monitored. Charts 1: Large downward movement in Hibor since early May, indicating extremely abundant micro liquidity in the Hong Kong stock market Data source: Wind, EPFR, CICC Research Department Charts 2: Active foreign funds currently underweight Chinese stocks by 1 percentage point compared to the benchmark Data source: Wind, EPFR, CICC Research Department Charts 3: Southbound trading volume has reached 35% Data source: Wind, EPFR, CICC Research Department Charts 4: Overview of the number of Mainland mutual funds and other mutual funds that invest in Hong Kong stocks Data source: Wind, CICC Research Department Charts 5: Overview of the 2Q25 Mainland actively managed equity funds that can invest in Hong Kong stocks, with a total of 2,200 funds and a total size of 1.56 trillion RMB... Note: Data as of June 30, 2025 Data source: Wind, CICC Research Department Charts 6: An overview of the 4,048 funds and a total size of 2.62 trillion RMB investable in Hong Kong stocks by the Mainland... Note: Data as of June 30, 2025 Data source: Wind, CICC Research Department Charts 7: Mainland mutual fund holdings in Hong Kong stocks have continued to increase, with Hong Kong stock holdings reaching 39.8% in 2Q25, up from 36.8% in 1Q25... Note: Data as of June 30, 2025 Data source: Wind, CICC Research Department Charts 8: Actively managed mutual funds in 2Q25 had 437.9 billion RMB in Hong Kong stock holdings, accounting for 32.5% of the total fund equity holdings... Note: Data as of June 30, 2025 Data source: Wind, CICC Research Department Charts 9: Mainland mutual fund holdings represent 15.4% of the overall Southbound allocated funds... Note: Data as of June 30, 2025 Data source: Wind, CICC Research Department Charts 10: Financial sectors like banks and insurance are at historically high allocation levels since 2021; whereas energy, real estate, and utilities are at historically low levels... Note: Data as of June 30, 2025 Data source: Wind, CICC Research Department