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This might be the best way to invest in China right now

Imagine if someone offered to sell you $100 for the price of $80. It’s a pretty good offer. And it’s similar to one that’s available to investors in the shares of Chinese companies listed on the Hong Kong stock market.

China hasn’t been kind to equity investors for the past year. Hong Kong’s Hang Seng Index and the Shanghai Composite Index have dropped 27 percent and 45 percent, respectively, over the past year. That compares with losses of 18 percent for the Singapore stock market, and 6 percent for the MSCI World Index.

Truewealth Publishing

Add that to China’s slowing economy, its growing debt burden and unstable currency, and it’s understandable why some investors have developed a phobia towards China’s markets.

But where some only see bad news, others see opportunity and value. For Chinese equities, the best opportunity and value are in the form of H-shares.

What are H-shares?

H-shares are the Hong Kong-listed shares of Chinese companies. They fall under the jurisdiction of Chinese law, but are denominated in Hong Kong dollars and are traded just like any other stock traded on the Hong Kong exchange. (They’re kind of like American Depository Receipts (ADRs) traded on the New York Stock Exchange – which are the shares of non-U.S. companies, but they’re traded just like a U.S.-based company on the NYSE.)

H-shares allow mainland Chinese companies to gain access to Hong Kong’s stock market, and foreign investors to buy the shares of Chinese companies. It’s not uncommon for a large Chinese company to have both A-shares (only tradeable on mainland exchanges) as well as H-shares.

Here’s why H-shares are attractive

One way to measure whether shares are cheap or expensive is the price-to-earnings, or P/E, ratio. It measures how much investors pay for one dollar of company earnings. The P/E can also be calculated for an entire index, like the Hang Seng China Enterprises Index (HSCEI), which tracks the performance of H-shares that are traded on the Hong Kong stock market.

The current P/E ratio for the HSCEI is 6.5. By comparison, the Shanghai Composite’s current P/E is 16 and the S&P 500’s is 19.4. Chinese shares traded in Hong Kong are extremely cheap.

HSCEI Truewealth Publishing

Another valuation metric tells the same story. The price-to-book ratio, or P/B ratio, compares share prices to the value of everything a company owns after its paid off its debts, or the book value. Between 2013 and 2015, H-shares averaged a P/B ratio of 1. But that’s fallen to a P/B of 0.81. That’s nearly 20 percent less than the cash you’d raise if you liquidated each company traded on the market. By comparison, the current P/B for the Shanghai Composite is 1.6.

HSCEI Truewealth Publishing

Of course, markets can always get cheaper. But when the majority of investors aren’t that interested in a market because the headlines look bad can be the best time to invest, which is the essence of contrarian investing. Going against the grain is never easy. But there are very good reasons to go against the grain right now.

The best way to invest in Hong Kong’s H-shares is via an ETF. For Singapore investors, you can look at the Lyxor China Enterprise (HSCEI) UCITS ETF (code: P58). It tracks the HSCEI index. If you trade on the Hong Kong exchange, you can track the HSCEI index using the Hang Seng H-Share Index ETF (code: 2828). If you can trade on the New York Stock Exchange, you can use the iShares China Large-Cap Fund (ticker: FXI).

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