June 9, 2017 / 6:52 AM / in a year

China investors flood into Hong Kong stocks as policy tightens at home

* China investors seek better-yielding Hong Kong shares

* Mainland market hurt by tighter regulations, slowdown fears

* Hong Kong stocks may correct, dry up flows - analyst

By Luoyan Liu and John Ruwitch

SHANGHAI, June 9 (Reuters) - Chinese money has helped Hong Kong stocks power to near two-year highs just when mainland markets appear to have stalled on China’s slowing economic growth and policy tightening.

The divergence in flows via the “Connect” schemes between the two markets became prominent in recent months with the Hong Kong leg seeing much greater usage compared with China-bound traffic.

“(Mainland) investors have been worried about economic growth, which possibly peaked in the first quarter, and also tighter financial regulations as the government stepped up deleveraging efforts,” said Yan Kaiwen, an analyst with China Fortune Securities.

Lopsided equity flows put the spotlight on Beijing’s efforts to attract investments and the progress it is making in reforms that have promised to open up its capital markets. They also come at a time when China has imposed tighter restrictions on taking funds out of the country to staunch outflows.

From January to May, a total of 168 billion yuan ($24.7 billion) flowed into Hong Kong via the pipelines, while northbound usage in the same period was 86 billion yuan.

The southbound leg of the Shanghai-Hong Kong connect dominated, recording a net flow of 133 billion yuan ($19.6 billion) in the first five months of the year, up nearly 80 percent from the same period in 2016.

The benchmark Hang Seng Index, meanwhile, has jumped about 18 percent since the start of the year, in stark contrast to a gain of about 1.8 percent in the Shanghai Composite Index .

China kicked off the landmark scheme connecting Shanghai and Hong Kong stock markets in November 2014 and the long-awaited link between Shenzhen and Hong Kong went live in December.

Analysts say demand for Hong Kong shares will likely continue as mainland markets come under greater regulatory scrutiny from a crackdown on risky lending practices and as the authorities tighten credit to ward off debt bubbles.

Chinese investors are also increasingly seeking companies with better valuations and the opportunity to diversify into non-yuan assets.

“Hong Kong stocks are favoured for their lower valuations and higher dividend payments compared with mainland peers, as institutional investors who emphasize fundamentals and valuations participate more in the southbound legs,” said Linus Yip, Hong Kong-based chief strategist at First Shanghai Securities.

The Shanghai stock market trades at a price-to-earnings multiple of around 16 times and the Shenzhen market at 34 times. In contrast, the Hang Seng index trades at 14 times earnings.

Hong Kong exchange data shows investors prefer large-cap dual-listed financial firms and industry leaders, including Bank of China, New China Life Insurance, Tencent Holdings and China Evergrande.

The index measuring price differences between dual-listed companies in Shanghai and Hong Kong stood at 122.23, 2.7 percent lower than the peak of 125.58 early this year.

Yip said investors should be wary of sharp gains in Hong Kong.

“If Hong Kong stocks go higher too rapidly, there could be a chance of a short-term correction and the (southbound) Connect flows could scale back.”

$1 = 6.7985 Chinese yuan Editing by Jacqueline Wong

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