| HONG KONG
HONG KONG For all the grand talk of far-reaching reforms when China's leadership meets early next month, foreign investors have refused to become carried away, with most choosing to shun the country's mammoth state-owned enterprises (SOEs).
The new leadership has been in place for a year, and investors are keen to see its strategy to keep the world's second largest economy growing, as it enters a more mature phase of slower expansion.
State-run news agency Xinhua reported on Tuesday that the Communist Party Central Committee should discuss "a new historical beginning that comprehensively deepens reforms" when it meets behind closed doors on November 9-12. And a senior Politburo member has promised "unprecedented" economic and societal reforms were on the agenda.
But investors harbor doubts over how far China's leaders will go to shake up SOEs in desperate need of reform.
"They have been long on talk and short on execution," said Dilip Shahani, HSBC's Hong Kong-based head of global research.
"They have highlighted industries where there are excesses, but such consolidation requires takeovers, liquidations and these are difficult to achieve in China."
State firms are riddled with issues like excess capacity, and poor corporate governance, and they have struggled to meet the challenges posed by China's shift towards more consumer-led growth.
Some, like those in the oil and gas sector, are considered prime candidates for an overhaul because they are simply too big. Others may be spared drastic action.
But investors are reluctant to take positions until Beijing's intentions become clearer.
SOEs dominate market capitalization in almost every sector, and global investment managers cannot duck taking a view on them altogether. For the past two years that view has been overwhelmingly bearish.
There are some early signs of a divergence, however. While investors remain cool to Chinese SOE debt, some appear to be warming up to opportunities in equities.
UNATTRACTIVE YIELDS, HEAVY SUPPLY
Large bond supplies from SOEs and prospects of the U.S. Federal Reserve withdrawing its multi-year campaign of quantitative easing are deterring buyers of Chinese corporate debt.
Another reason why some are averse to investing in SOEs can be their sensitivity to policy shifts in Beijing.
"Even if you like a company, a change in government policy can completely upend your positions," said a fund manager at a U.S. fund in Hong Kong that manages more than $5 billion in Asian debt. "You are better off getting value from other investment grade names in Asia."
An index that measures the performance of emerging market investment grade bonds compiled by JP Morgan shows an indicative yield of 5.7 percent, according to Thomson Reuters Datastream.
By comparison, China National Offshore Oil Corporation, a proxy for the China SOE space, has a bond maturing in 2023 yielding just 4 percent.
With benchmark U.S. Treasury yields up nearly a percentage point from May's lows and set to rise further, it becomes even harder to justify investing in SOE bonds at these levels.
There is also no scarcity of supply.
Bond issues by China's SOEs have notched a record, with more than $25 billion issued since the start of the year, accounting for a fifth of total new issues in Asia, excluding Japan, according to Thomson Reuters data.
WORTH A SECOND LOOK
But viewed through the equity lens, China's SOEs are starting to become attractive even though its state-owned banks, which dominate this space, have been riven by concerns over bad debts, shadow banking and growth in wealth management products.
Investors have begun taking notice of a yawning valuation gap - in some cases at multi-year highs - between SOEs and private companies, such as those in the technology and gaming sectors.
The gap between the price-to-earnings ratio for a basket of the biggest private companies in Hong Kong/China and for the SOE-heavy MSCI China index is at its highest in more than five years. link.reuters.com/xyd34v
The top three most underweight stocks in global fund managers' Asia-focused portfolios are China's state-owned firms - China Construction Bank (0939.HK), ICBC (1398.HK) and China Mobile (0941.HK), according to Bank of America Merrill Lynch.
While the most overweight stock across Asia is Chinese internet search firm Baidu (BIDU.O).
"Global and dedicated investors are exceptionally underweight the unpopular state capitalist sector (SOEs), and egregiously overweight "growth-oriented" consumer, internet, telecoms names," said BofA-ML's Ajay Kapur in a note.
(Additional reporting by Michelle Chen and Nethelie Wong; Writing by Saikat Chatterjee; Editing by Simon Cameron-Moore)