'Through train' program is expected to inject new life into equities in Shanghai, reports Emma Dai in Hong Kong.

Editor's note: The Shanghai-Hong Kong Stock Connect, popularly known as the "through train", is expected to launch next month and offer cross-border trading of mainland companies' dual-listed shares. The program, initially proposed in 2007, holds promise for the development of the nation's capital markets but also raises new issues of valuation and trading strategies.

The success of this arrangement can rationalize the diverging prices of dual-listed shares and help catapult the Shanghai Stock Exchange to the ranks of international exchanges. It will also provide immense profit opportunities for global institutional investors, whose increased presence is expected to re-shape the market.

Four-party agreement signed for Shanghai-HK stock connect

Institutions 'take the A train' for arbitrage profits

Trading under the Shanghai-Hong Kong Stock Connect arrangement is widely expected to be dominated by institutions, which take a far longer-term view than retail investors, according to analysts in Hong Kong.

The program could lead to a fundamental re-rating of Shanghai's A-share market, which many analysts believe is oversold at an average price-earnings ratio of 10.73, compared with 11.45 for Hong Kong and 19.8 for New York.

Even such discounted prices have not enticed many retail investors, who just want short-term gains, analysts said. But they expect that a large inflow of investment through Hong Kong will change that.

"Foreign institutions we have talked to are interested in companies that have the potential to outperform their peers over a three-year horizon, rather than three months. That's so different from retail investors, who only care about how much profit they can pocket in three weeks," said Liu Hongke, chief economist and deputy head of research at China Construction Bank International Securities Ltd.

Lilian Leung, executive director of JP Morgan Asset Management, said: "We are expecting a market re-rating of A shares in the second half.

"The Shanghai-Hong Kong Stock Connect is a potential catalyst of the rally." she said. "Though it is just the start of the liberalization of the equity market, with much easier access to A shares, foreign institutions may finally change the investor structure of the market, which has until now been dominated by retail investors."

Leung, who has been involved in A-share research since 2005 and manages a fund worth 500 million yuan ($81.4 million) under the renminbi qualified foreign institutional investor program, said the market is rallying because the economy is stabilizing and because structural reform will fuel the country's long-term growth.

She also noted that the overall valuation of A shares has been "low" after a five-year contraction.

"Some of the big-cap good-quality companies are undervalued. They will be the first beneficiaries of the stock connect program," she said. "With increasing participation of foreign institutional investors and their buying power as a new force ... the whole market will be driven up as well."

Liu said that many State-owned large-caps are unpopular in the A-share market because retail investors shun them.

"But some of the companies are quite well-managed," he said. The leadership of China Mobile Ltd "is the most farsighted among the telecom firms I have visited".