In recent times, there has been a noticeable uptick in the involvement of public funds in the Hong Kong stock market, particularly as it relates to the increasing participation of mainland investorsAccording to the latest statistics from the Hong Kong Stock Exchange, the second quarter of 2022 saw an average daily trading volume of HK$128.735 billion in the main board market, marking a decline of 10.88% compared to the previous quarterSimilarly, the average daily turnover for the Stock Connect, which allows mainland Chinese investors to trade Hong Kong stocks, dropped from HK$347.04 billion in the first quarter to HK$302.33 billion in the second quarter, indicating a decline of 12.88%. This suggests that the trading appetite for southbound funds has taken a significant hit during this period, reflecting a cautious market sentiment.

Despite this downturn in trading volumes, the total market value of Hong Kong stocks held by southbound funds actually increased from HK$1.65 trillion to HK$1.89 trillion, amounting to a 14.55% rise within the same timeframe

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Furthermore, reports from public funds show that there has been a substantial increase in their investments in Hong Kong stocks, with the market value of their top holdings climbing by HK$55.5 billion, which constitutes a remarkable increase of 29.50% compared to previous quarters.

This begs the question of whether there are investment opportunities in Hong Kong, and if so, where those prospects lieDiving deeper into the data reveals that public funds have indeed made a hefty bet on Hong Kong listings as they reversed a long-standing trend of divestmentFor instance, during the second quarter, public funds significantly boosted their positions, leading to a cumulative value of HK$243.5 billion in their top ten Hong Kong stock holdings, a notable increase from the last quarter.

An interesting observation is that, as of the end of the second quarter, the market value held by southbound funds amounted to HK$1.89 trillion, which represents a growth of HK$242.1 billion from the previous quarter, effectively demonstrating that public funds are amassing positions at a rate that surpasses the average

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As a result, the share of public funds within the total southbound portfolio increased from 11.2% to 12.88%, thereby raising their influence within the market significantly.

Moreover, the second quarter also showcased a rise in the proportion of Hong Kong stocks within public fund holdingsBy the end of that quarter, public funds held HK$3.55 trillion across ten major stock holdings, with $243.5 billion allocated to Hong Kong listings; this is an increase from HK$3.23 trillion and HK$188.1 billion, respectively, observed at the end of the previous quarterThe representation of Hong Kong stocks in these holdings increased from 5.82% to 6.86%, indicating a 1.04 percentage point rise.

However, it's essential to recognize that while the inflow of southbound capital and the positioning of public funds in Hong Kong stocks is on the rise, their impact remains somewhat limited within the broader Hong Kong main board market

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For context, at the end of the second quarter, the total market value of southbound investment (HK$1.89 trillion) only accounted for 4.85% of the main board's valuation, an increase from 4.25% in the prior quarterAdditionally, the total market value of public funds focused on Hong Kong stocks (HK$243.5 billion) made up a mere 0.74% of the total market value.

When considering the 709 stock connect candidates from that timeframe, the market capitalization surged from HK$25.06 trillion to HK$26.37 trillion, allowing southbound holdings to rise from 6.58% to 7.17%, showcasing a 0.59 percentage point increaseHowever, the trading momentum during this period indicates that while southbound capital flows were substantial, it became evident that trading intentions had decreased.

Although the public funds have yet to disclose detailed trading volumes in their periodic reports, the increased positions they are taking suggest that they wield growing influence over the pricing of stocks they hold

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It's also noteworthy that a 2020 survey by the Hong Kong Stock Exchange revealed that foreign investors contributed 41% of the total market trading volume, with institutional investors accounting for 36% of thatThis makes up for a significant portion of the market, particularly as the Hong Kong Stock Connect trading surged from 8.60% of total market transactions in 2019 to this figure, underscoring a rising trend.

Statistics indicate that as of late July, the average price-to-earnings ratio for the Hong Kong main board was at 10.27 times, down nearly 40% from the previous year (16.78 times), while the average dividend yield has remarkably risen from 2.27% to 3.46%. This scenario lays the groundwork for a potentially ripe environment for investors seeking opportunities in undervalued stocks.

Focusing on the public funds' investments within sectors reveals tech firms continue to pique the interest of these funds

In the second quarter, three of their top ten holdings were from the technology sector, which included Meituan, Tencent Holdings, and KuaishouAn important shift, however, saw Meituan ascend to become the largest publicly held stock, displacing Tencent Holdings, which had maintained the number one position for an extensive period of six years.

The rise of Meituan has been attributed significantly to its ability to enhance user engagement amid ongoing pandemic control measuresDuring this quarter, public funds amplified their holdings of Meituan by an impressive 77.02 million shares, equating to a 48.18% increase, while the number of funds holding it surged from 233 to 458. This strongly indicates the confidence of funds in Meituan's growth trajectory.

Conversely, Tencent Holdings has seen its position shift, serving now as the second-largest stock among public fund holdings

Yet, this is not due to a reduction in stake by public funds, as they increased their positions of Tencent by 819,000 shares, reflecting a growth of 9.70% in its holdings this quarter.

As for Kuaishou, it has steadily gained attention since the third quarter of the previous year, with public funds holding 143 million shares, an increment of 28.26 million shares during the second quarter aloneThese trends reveal a broader shift towards sectors that cater to less essential consumer needs, such as automobiles, food and beverages, textiles, and apparel.

Within the automobile sector, there has been a notable evolution in public funds' interestsThe previous quarter only had two companies in the top-reported holdings: Great Wall Motors and BYD CompanyHowever, by the end of the second quarter, four brands were included, namely Great Wall Motors, Geely Automobile, BYD Company, and Li Auto, all showing strong positions among the funds.

In the food and beverage industry, companies like China Resources Beer and Nongfu Spring saw increased purchasing activity from public funds during the second quarter

For textiles and apparel, public funds aggressively raised their stakes in brands such as Li Ning, Xtep International, and Bosideng.

On the contrary, the energy sector demonstrated varied investment approaches as public funds continued augmenting their investments in China National Offshore Oil Corporation, where they increased shares by 259 millionWhile they reduced their stakes in other previously significant positions, clearly reflecting their strategy of reallocation within the energy segment.

Within the finance sector, public funds demonstrated a notable decrease in holdings among major domestic banks, including China Merchants Bank and Postal Savings Bank, shedding significant portions of their investmentsThe real estate sector also drew attention, with public funds accumulating brands such as Country Garden Services, which might reflect a growing interest in property management stocks.

It is important to understand that the respective judgments of value in stocks from various sectors sometimes differ between public funds and the overall southbound historically associated investments

For example, public funds boosted holdings in Great Wall Motors and China Resources Beer while southbound capital reduced stakes in these stocksConversely, there were cases where southbound funds invested more into companies that public funds cut back on.

Additionally, there’s a growing trend when looking into Hong Kong-themed public funds, with a total of 194 funds reported at the end of 2021. These funds, which boast total assets of HK$156.95 billion, have increased in diversity and scaleBy the end of the second quarter, the leading stocks across these actively managed funds had 392 Hong Kong-listed securitiesThis reflects an expansion of their holdings in Hong Kong stocks, showing an active appetite for key investments within this market despite fluctuations in trends.

An obvious yet intriguing trend is that amid the expanding portfolio of Hong Kong stocks, there might be a slight adjustment in their weightings within the funds, indicating an adaptive strategy as funds recalibrate their investment priorities