China may be growing at its familiar double-digit pace, but you wouldn’t guess that from the way Chinese equities are performing. Many investors are surprised to hear that mainland shares are among 2010’s worst performers, down 22% since the start of the year. They’re even more surprised to find that a disconnect like that is perfectly normal for this most peculiar of markets.

When talking about Chinese shares it pays to be precise, because the term refers to several very different assets and investors regularly get them confused. So let’s quickly recap. ‘Mainland’ usually means the A share market, which consists of shares in firms incorporated in China and listed on the dual mainland stock exchanges in Shanghai and Shenzhen (generally, larger firms are listed in Shanghai and smaller ones in Shenzhen).

These shares are denominated in renminbi and traded almost exclusively by Chinese citizens. The total quotas for qualified foreign institutional investors amount to around US$17 billion at present, which is insignificant in the context of a US$3 trillion market capitalisation. There’s also a second parallel mainland market in B shares, which are denominated in US dollars (Shanghai) and Hong Kong dollars (Shenzhen). This market is open to foreign investors and Chinese citizens with foreign currency accounts, but it’s essentially moribund.

Instead, foreigners usually invest in Chinese companies through Hong Kong listings of H shares (mainland-incorporated firms listed in Hong Kong), red chips (state-controlled but incorporated and listed in Hong Kong) and P chips (non-state firms incorporated and listed in Hong Kong). Many private mainland firms also choose to list in the US or Singapore, while many Taiwanese firms have some or all of their assets in China.

Stocks listed outside the mainland have historically moved in line with the rest of the world’s markets. But the A share market marches to a very different beat. As the chart below shows, A shares have typically had no consistent correlation with what’s going on elsewhere.

That’s probably not very surprising given how closed China’s capital account is. That US$17 billion in QFII money is too small to have any impact and can’t really be taken out of the country anyway as the manager would have no chance of ever putting it back in. Consequently, China is very different to the average emerging market, which is subject to the ebbs and flows of global risk appetite. Of course, hot money flows in and out of China via various routes, but where that gets funnelled into assets, property is probably a more common choice than equities.

1 | 2 | 3 |