Shanghai’s stock market is now open to foreigners. Should you buy in?

Canadians can now invest in Chinese stocks directly. But there’s reason to be cautious

The sun rises behind the skyline of Pudong's Lujiazui Financial District in Shanghai on October 28, 2014.

The sun rises behind the skyline of Pudong’s Lujiazui Financial District in Shanghai in October 2014. (Johannes Eisele/AFP/Getty)

It’s been 23 years since the first Chinese-based company became available for foreign ownership. Back then, outsiders could only invest in the country’s stocks that were traded in Hong Kong or New York. Many millions of shares in Chinese companies have since been bought and sold by foreigners, but none of those stocks changed hands in mainland China.

That all changed in November, when the country opened the Shanghai Stock Exchange to non-Chinese investors. “This will become quite significant over time,” says Christoffer Enemaerke, an emerging markets analyst with RBC Global Asset Management. “It’s not part of any emerging market benchmark yet, but it will be fully included in the future.”

Canadians can now buy shares in about 570 Chinese companies that they may not have been able to before. Shanghai is a vastly different market than the Hong Kong exchange, where most foreign trading of Chinese stocks has taken place to date. About two-thirds of the market is made up of small-capitalization stocks, versus about 20% in Hong Kong, says Enemaerke. With a higher concentration in financial, health-care and industrial stocks, Shanghai is more representative of the Chinese economy.

This market also presents different opportunities, especially in the large-cap space, says Louis Lau, director of investments for Brandes Investment Partners. Because domestic retail investors account for about 80% of the exchange’s activity, it’s a highly speculative market, with most people focused on short-term gains. That has left the large-caps mostly ignored. There are airports, railways, liquor businesses and more trading at a “significant” discount to similar operations listed on other exchanges, he says.

Shanghai is also relatively uncorrelated to other global markets, in part because it has been so isolated for so long, says Enemaerke. It has a 0.4 correlation to broader equities, compared to Hong Kong’s 0.8 (1 denotes exact correlation). “That can make it a good portfolio diversifier,” he says, adding that its behaviour could change as more money flows into the market.

As interesting as this new exchange may be, it is risky to get in now. Many companies don’t have the same reporting standards as foreigners are used to. Some only report in Mandarin; others don’t even have annual reports, says Enemaerke. It’s hard enough for analysts to find out what’s going on in some of these companies; it’ll be nearly impossible for individual investors.

China also imposes rules that could trip up investors. A company can’t have more than 30% foreign ownership and no more than 10% of a firm’s shares can be owned by one person, says Lau. Still, the market has climbed by 9% since foreign trading began. Enemaerke advises taking a wait-and-see approach. There aren’t many Shanghai-invested funds to choose from yet—that’s the best way to buy in, he says—but they’ll come.

In time, the Shanghai Stock Exchange will offer more ways for Canadians to invest in a country that still has a lot of potential. It will likely become more transparent and less volatile in order to compete for global capital. “The private sector is becoming more and more important in China,” says Enemaerke. “This is an interesting market for investors with a long time horizon.”