China’s Nasdaq

China’s STAR market debut offers a good risk management lesson

Individual stock market investors should be aware of the need to manage risks after wild swings in share prices during the first two days of trading on China's new Nasdaq-style board.

It was the epoch of belief, it was the epoch of incredulity.

This sentence is the best summary of the first trading day of the Shanghai Stock Exchange’s STAR Market, also known as the technology innovation board.

Many stock market investors in China experienced the most exciting day in their investment careers as they saw shares skyrocket at STAR market’s launch on Monday.

A total of 25 companies made their debut on what is known as China’s Nasdaq, referring to the technology-heavy board that currently hosts some of the fastest-growing companies in the US.

The STAR market got off to a robust start with stocks recording an average gain of 140% at the end of the trading day. Anji Microelectronics Technology, a Shanghai-based semiconductor material supplier, was the biggest gainer with shares soaring by as much as 521% at one point during Monday trading before closing up 340% from its listing price.

A total of 16 out of the 25 debutants have seen their shares more than double. Even the weakest among them, Harbin Xinguang Photoelectric Technology, surged 58%.

“The first day of STAR Market is a happy ending for everybody,” Mark Chen, an alternative investor in Hong Kong, told FinanceAsia. “But I don’t think investors should take these debuts for granted, as future listings on the STAR Market may not yield the same levels of gains.”

MARKET-DRIVEN PRICING

The buying spree came on the back of Beijing’s goal to establish a more market-driven stock pricing mechanism for the STAR market. In an unprecedented move, the securities regulator has allowed prices to move freely in the first five trading days, after which shares will be subject to a 20% cap on gains and losses every day.

They represent a significant relaxation over rules on Shanghai’s main board, where initial public offerings are subject to a maximum gain of 44% in the first trading day and a 10% cap on gains and losses thereafter.

Beijing imposes tight control over share price movements to control market volatility.

Chinese stock market investors, particularly those focusing on IPOs, have long been considered irrational and speculative. Generally speaking, they have a weaker sense of risk management because they are protected by the pricing framework.

Many IPOs in China are often seen as a no-brainer because valuations are manually controlled at below-market levels. China’s securities regulator does not allow companies to price their IPOs higher than 23 times earnings.

Together with the price limits, it is common for IPOs to pop 44% on the first day and 10% for each of the following few days. For individual investors, it is a no-brainer to bid at those levels.

To that end, it is fair to say that the STAR market provides a good risk management lesson for individual investors. Instead of putting in bids at capped levels, they need to manage their downside risk and consider whether their bids are really worth the money.

This is particularly true given that most of the stocks fell on the second trading day, Tuesday. Many investors, especially those who bid at peak levels on Monday, may already have had their hands burned. At the end of Tuesday trading, all but four of the 25 stocks fell with losses ranging from 1% to 18%.

For those who have suffered losses, it is perhaps a timely reminder of the need to understand the target company’s fundamentals instead of chasing IPOs blindly. Corporate analysis is particularly important in the STAR market because many of the companies are early-stage businesses that are harder to value, even for sophisticated investors.

Ideally, the roller-coaster ride for many STAR market investors over the past two days will prompt Chinese individual investors to become more rational in their investment decisions.

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