A popular strategy pops up in Hong Kong around this time each year: betting on which stocks will be added to a trading link giving mainland buyers easy access to the city’s shares.
The trade is simple enough: buy stocks of likely candidates in advance and sell on inclusion. Shares added to the Hang Seng Composite Index in the March and September reshuffles last year, and included in the trading connect shortly after, jumped an average 27%, based on their prices 20 days before and after the index announcement, according to Mizuho Securities Asia Ltd.
The potential gains may be even bigger this year given optimism over the increasing participation of Chinese investors in Hong Kong. There’s also speculation there may be a record number of additions to the so-called Southbound Stock Connect trading link.
“It’s a popular strategy and people are setting it up much earlier than last year,” said Andy Zhou, a sales trader at Market Securities Hong Kong Ltd. “These trades are heavily one-sided and crowd quickly. Given the thin liquidity of some HSCI candidates, you want to be early, and watch the average daily volume carefully.”
Eligibility for inclusion in the trading link between the mainland and Hong Kong is based on constituents in the HSCI, but is also reviewed by the Hong Kong exchange and other authorities. In addition to the major reshuffles in March and September, ad hoc changes can also take place through the year.
Morgan Stanley and Mizuho have both pitched trading strategies to their clients ahead of the next review by Hang Seng Indexes Co. due this Friday. The index changes will come into effect from March 9, and the list of stocks that will be added to the Southbound link is expected to be announced shortly after that.
Morgan Stanley recommended investors buy its list of 44 potential Southbound inclusion candidates and sell its 25 likely deletions, entering the positions on Feb. 9 and exiting on March 9. Potential additions include Jingdong Industrials Inc., OneRobotics Shenzhen Co., Deepexi Technology Co. and Bank of East Asia Ltd., based on its research note.
Mizuho has compiled a list of 48 potential additions and 28 deletions for its clients to base their trading on.
Last year’s average return of 27% for Mizuho’s Southbound inclusion strategy was an exceptional one, though it was also boosted by a rally in the overall stock market. The strategy lost 3% in 2024 and gained 1% in 2023.
The potential trade is underpinned by the growing flood of mainland money coming into Hong Kong’s stock market. Chinese investors bought a record HK$1.4 trillion ($179 billion) of Hong Kong-listed shares and exchange‑traded funds last year via the Stock Connect link.
Mainland investors now hold more than half of the total shares issued by some smaller Hong Kong companies, based on data from the stock exchange. Southbound flows currently account for 25%-to-30% of the trading volume of the city’s stocks on an average day, according to estimates from Morgan Stanley.
“This strategy only becomes powerful when southbound flows are large enough to move prices,” said Laura Wang, chief China equity strategist at Morgan Stanley in Hong Kong. “Once flows reach that scale, inclusion in the trading link becomes a major catalyst for shares.”
This year’s timing is complicated by the start of Lunar New Year next week, which means the trading window following the index announcement is shorter than usual. There is also the trend of investors entering earlier, which is adding to volatility.
“Investors are entering trades increasingly early, which heightens timing risk for both positioning and exit and requires more active monitoring of market sentiment,” said Willer Chen, an analyst at Mizuho in Hong Kong. Still, the strategy should remain effective, he said.
