Investors are expected to exploit the widest price gap in Alibaba Group Holding shares, after a rally in Hong Kong drove its valuation above those listed in New York. The opportunity, though, may be fleeting in a volatile market.

The e-commerce giant's equity has gained 22.6 per cent this month through July 21. Its American depositary receipt, whose value is equivalent to eight Hong Kong-listed shares, rose by 19.6 per cent in the same period.

An investor who exchanges the ADRs at the equivalent of HK$249.88, based on overnight closing prices in New York, could them sell them on in Hong Kong for HK$254.80 each, assuming no transaction costs.

As both instruments are fungible, ADR holders would need to switch into local shares before they can exploit the 2 per cent price differential in Hong Kong, a trade known as arbitraging in stock market parlance.

Jack Ma, China's richest man, controls about 50 per cent of the voting interest in Ant Group. Photo: EPA-EFE alt=Jack Ma, China's richest man, controls about 50 per cent of the voting interest in Ant Group. Photo: EPA-EFE

"The price gap will lead investors to do the arbitrage trade," said Louis Tse Ming-kwong, managing director of VC Asset Management. "Investors who have bought Alibaba in the US since its listing in 2014 will find it is a good opportunity to shift into Hong Kong shares now."

The bounce in Alibaba shares follows an emphatic rally in its stock after an announcement by Ant Group, the operator of the Alipay payments system valued at US$200 billion, about concurrent stock offerings in Shanghai and Hong Kong.

Alibaba, which owns about a third of Ant based on recent filings, is the owner of the South China Morning Post.

The arbitrage opportunity has also arisen amid a bullish mood across mainland and Hong Kong bourses since the Chinese government imposed a controversial national security law in the city on June 30 to help restore social order.

A slew of mega listings involving Chinese technology firms has also underpinned the flow of hot money into the Hong Kong financial market. Since Alibaba's secondary listing in November, its US-listed peers including JD.com and NetEase have also followed suit.

Their "homecoming" may have prompted index compiler the Hang Seng Indexes Company to create a gauge to track 30 of the largest technology firms in Hong Kong. The Hang Seng Tech Index will kick off on July 27. Their entry into the benchmark Hang Seng Index could be decided in August, after the compiler concluded a round of public consultations in May.

Still, the window of arbitrage opportunity can open and shut rather quickly, just like in December. Alibaba stock fell 3.5 per cent to HK$248 as the broader market tanked, narrowing the price gap. It remains to be seen how the ADRs will react.

Hong Kong stock exchange to get new tech index tracking Alibaba, Tencent and 28 other peers

On top of arbitraging, the jostle for Alibaba shares may have also been driven by such early positioning by fund managers who typically track index-component stocks. Alibaba alone would have an 8 per cent weighting in the proposed tech index, based on a simulation.

"Many international fund houses could take the opportunities" to switch, said Tom Chan Pak-lam, chairman of Hong Kong Institute Securities Dealers, an industry body of brokers. "They may not move back to the US markets for fear that the Trump administration may restrict US funds from investing in Chinese tech firms."

Investors have switched into 57.64 million Alibaba shares in Hong Kong since its secondary listing, according to exchange data. There were 4.81 billion shares kept in the Hong Kong clearing house as of Monday, or 22.4 per cent of its capital.

"Hong Kong is the home market for Chinese tech companies," Chan added. "Hong Kong investors are more familiar with these companies. As such, it may be natural for Hong Kong-listed shares to be trading at a premium over those in the US."

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2020 South China Morning Post Publishers Ltd. All rights reserved.

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