CAPITAL from mainland China continues to spill over the border into Hong Kong, contributing significantly to the city’s stock exchange, as the southbound flow through the stock connect is expected to continue to rise.

For the unfamiliar, southbound trading is when mainland investors in China use the Shanghai-Hong Kong Stock Connect or the Shenzhen-Hong Kong Stock Connect to participate in the Hong Kong market. Northbound trading, the reverse, is when investors in Hong Kong use the stock connects to invest in Shanghai/Shenzhen-listed stocks.

“The need for overseas asset allocation in China will continue to grow. Mainland investors like Hong Kong stocks. The trend indicates that the momentum of the southbound flow will be maintained,” says Dennis Lam, director, chief investment office, at UBS Wealth Management.

“Mainland investment now accounts for 10% of the Hong Kong stock market,” says Lam, noting that southbound flow is expected to rise to 20% of the total trading volume in the Hong Kong market in the future, becoming one of the major drivers for Hong Kong stocks.

The increased participation of Chinese investors in Hong Kong’s market is seen as a positive, due to the continued growth of China’s economy.

“People are considering whether they should sell their shares. But the Hong Kong market is expected to experience a robust rise next year, benefiting from China’s continuous good economic performance and the rising influence of the southbound flow. Selling stocks too early can be costly,” says Lam. “We take a positive outlook for H-shares which is supported by the profit and P/E ratio.”

China’s GDP growth will slow a bit to 6.4% in 2018, according to UBS. Mainland China’s economy will be driven by reforms regarding the supply side, state-owned enterprises and financial system, according to Yifan Hu, managing director, regional CIO and chief China economist at UBS Wealth Management. Opportunities could also rise from the upgrading of manufacturing industry and the development of environmental protection sector, she adds.

Despite the potential benefits of increased mainland participation, there is the concern that the increase in southbound traffic could turn the Hong Kong market into another A-share market dominated by individual investors gambling on small-cap stocks. However, this is unlikely, as the Hong Kong market is still dominated by foreign and institutional investors, according to Lam.

More than US$40 billion has been invested in Hong Kong stocks this year, but the current level of mainland participation still gives room for growth. “Less than 5% of mainland investors are using the mainland-Hong Kong stock connects. This indicates great potential for the growth of southbound flow,” Lam explains.