Tian Ding at the School of Economics and Management, University of Chinese Academy of Sciences (et al.) wondered if an analysis of southbound (i.e. China money into Hong Kong stocks) fund flow via the stock connect program had predictive ability?
Northbound flows have been extensively studied to see how ‘smart money’ affects stock prices in China but until now the southbound flow has been less analyzed. Conventional wisdom runs along the lines of, ‘why bother anyhow? It’s just a bunch of trend following know-nothings randomly popping off at the latest memes, right?’ Not so as it turns out.
The work highlights a remarkable “..information heterogeneity between mainland and Hong Kong investors.” which is academic-speak for the smart money, in fact, appears to be not the south=>north crowd but the mainland hayseeds coming north=>south.
Using the findings of their work the researchers constructed a theoretical portfolio and on testing discovered this produced a near 26% annual excess return. There are obvious caveats: expenses are not ignored but may not reflect a real world situation, the model necessarily looks backwards and past performance may not be a good guide to the future.
Having said that, what’s clear is when mainland investors come south they do so with an informational advantage. When sophisticated investors go north they go with an analytical advantage. Short term the well-informed do better than the well-educated.
What’s especially interesting and of note is price moves driven by the thundering herd from the north tend to persist. I for one will be paying much closer attention to southbound flows in future!
The work in full is here Asset Pricing, Cross-Border Capital Flows, and Return Forecasting.
Happy Sunday.