Since late February, escalating and prolonged tensions surrounding Iran, coupled with a volatile situation in the Strait of Hormuz driving up oil prices, have created significant disturbances across global financial markets. Volatility has increased noticeably for assets including gold, U.S. Treasuries, U.S. stocks, A-shares, and Hong Kong stocks. Against this backdrop, the movements of Middle Eastern capital have become a key market focus. Key questions include whether these funds will invest in Chinese markets as a diversification and hedging strategy, and whether they might sell U.S. assets such as Treasuries, equities, and unlisted AI-related holdings, potentially causing secondary market impacts.
Recent statements from Hong Kong officials and media reports have further heightened market attention on this topic. So, has Middle Eastern capital already flowed into the Hong Kong market? What factors could catalyze such inflows? Which Chinese assets are more attractive to Middle Eastern investors?
Why is the market focused on Middle Eastern capital? The narrative centers on hedging needs, reinforced by official comments, media coverage, and market expectations. 1) Persistent Middle Eastern geopolitics fuel the hedging narrative: The ongoing regional tensions expose local capital to significant risk. On one hand, external capital and business operations centered in Middle Eastern financial hubs face short-term disruption risks and long-term stability uncertainties, potentially seeking new "safe havens." Recent sharp declines in Middle Eastern stock markets and Dubai property prices, alongside outflows from the region tracked by EPFR, exemplify this trend. Hong Kong, as a mature and stable financial center, is well-positioned to absorb these capital transfers. On the other hand, substantial sovereign and institutional capital within the Middle East may seek further diversification due to the conflict. This could involve increasing allocations to Chinese assets, which have lower correlation to global energy and geopolitical volatility, to hedge against potential future instability. This is a plausible narrative, especially since Middle Eastern sovereign institutions and 13F-filed institutional holdings remain heavily weighted toward U.S. assets.
2) Official statements and media reports amplify focus: Hong Kong's Financial Secretary, Paul Chan, stated on the 7th of this month that Hong Kong faces both "risks and opportunities" from the Middle East conflict, suggesting Middle Eastern capital might seek safety in Hong Kong, for which the government has prepared. This signal strengthened market focus. Concurrently, numerous media reports on the global allocation trends of Middle Eastern capital have further fueled expectations.
3) Market anticipation for foreign capital amid tight liquidity: Analysis suggests Hong Kong's stock market liquidity will shift to a "tight balance" by 2026. Southbound inflows may be lower than last year due to a more active A-share market and a stronger Renminbi, while IPO and secondary financing activity is expected to be higher. Consequently, foreign capital is widely seen as a crucial incremental source. Currently, foreign investors remain underweight Chinese assets by approximately 1 percentage point. Compared to European or American funds, Middle Eastern capital is clearly subject to higher expectations.
4) Market micro-signals: Certain stocks favored by foreign and Middle Eastern investors, such as CATL (Contemporary Amperex Technology Co.,Ltd.), show a deepening AH share premium discount.
Has Middle Eastern capital already flowed into China? There are indirect and micro-level clues suggesting some inflows into Hong Kong, but no evidence yet of substantial entry into the stock market. Is there evidence of capital returning? Synthesizing data from EPFR flows, exchange rates, interbank liquidity, and Hong Kong stock turnover reveals some indirect clues of short-term inflows into Hong Kong, including the deepening AH premium discount for specific stocks. However, no direct evidence of large-scale inflows into the equity market has been observed, such as in overall market turnover or EPFR flow trends. Possible explanations include: the diversification process for Middle Eastern capital is inherently gradual and unlikely to materialize as massive inflows within weeks; or external capital relocating to Hong Kong as a base may not directly enter the stock market. - EPFR Flows: Following the Iran tensions, overall active foreign capital turned to net outflows, ending a seven-week net inflow streak since the start of the year. Breakdowns show European and U.S. active funds were the main contributors to outflows, aligning with typical patterns after geopolitical risks emerge. Active Hong Kong and other regional funds saw some inflows. However, EPFR data cannot capture funds entering Hong Kong but not the stock market. - Market Turnover: Overall market turnover has not expanded. In fact, average daily turnover in Hong Kong declined from the first week of March. In contrast, turnover for specific stocks like CATL's H-shares expanded, and their AH premium discount widened significantly, suggesting any potential inflows are not yet large enough to impact the broader market. - Liquidity and FX: Declining HIBOR rates and a weakening Hong Kong dollar suggest subdued marginal demand for HKD, which, while not direct proof of absent foreign inflows, indicates overall weak local currency demand.
What drives Middle Eastern capital flows? Short-term hedging needs of external capital vs. long-term diversification demands of local capital. When discussing Middle Eastern capital, it's essential to differentiate based on its nature to understand flow drivers and directions. Middle Eastern capital is not monolithic and can be broadly categorized into external capital domiciled in the Middle East and local Middle Eastern capital. The former may be more influenced by short-term hedging needs, while the latter focuses on long-term diversification, which is key to predicting their allocation direction. - Type 1: External capital domiciled in the Middle East, such as family offices, quant and other institutions, and newly established foreign operations. This capital, primarily private, includes long-term accumulations from Gulf royal families and traditional industrial families in sectors like energy, real estate, and infrastructure. It also includes wealth attracted by the rise of financial centers like Dubai and Abu Dhabi, benefiting from relatively lax regulation and tax advantages. This capital typically allocates to stable, liquid assets but also actively invests in alternatives like private equity and real estate. Current regional instability makes this capital more likely to reconsider its geographic footprint for hedging reasons. Hong Kong, leveraging its status as an international financial center and China's economic resilience, could be a destination. However, such inflows might prioritize establishing offices in Hong Kong, with uncertain direct investment into Hong Kong or A-shares. - Type 2: Local Middle Eastern capital, such as sovereign wealth funds and globally allocating institutions. This includes major sovereign funds like Saudi Arabia's PIF and Abu Dhabi's ADIA. These are large-scale funds with significant AUM, characterized by diversified global allocations, heavily focused on developed markets like the U.S. and Europe. For example, ADIA allocates 45%-60% to North America. These funds are driven more by long-term diversification needs. Based on EPFR data, market liquidity, and FX metrics, no clear evidence of significant回流 is currently observed. In the medium to long term, driven by diversification and risk dispersion, these funds could increase allocations to China. Core reasons include: 1) Reducing over-reliance on U.S. markets and mitigating potential policy uncertainty; 2) Attractive long-term valuation of Chinese assets globally; 3) Industrial synergy, aligning China's strengths in new productive forces like new energy and advanced manufacturing with the Middle East's "post-oil era" transition needs. Compared to Type 1 capital, these inflows have a higher threshold, requiring clear long-term return expectations, mature market mechanisms, and industrial synergy, leading to more rational and slower allocation decisions.
What is the allocation picture for Middle Eastern capital in China? Recent active participation in IPOs and private placements, focusing on traditional resources, new energy, advanced manufacturing, and tech. Synthesizing the above, Middle Eastern capital inflows are more likely to be a long-term, gradual diversification process rather than a short-term surge, focusing on Chinese core assets in new energy, advanced manufacturing, and technology, rather than broad-based investment. This aligns with the trend of increasing but selective Chinese exposure over recent years. - Participation has clearly increased: Middle Eastern sovereign funds have been prominent as cornerstone investors in recent Hong Kong IPOs. For instance, the Kuwait Investment Authority was a major cornerstone investor in CATL's Hong Kong IPO. ADIA has also been a significant cornerstone investor in other recent Hong Kong IPOs. - Beyond sovereign funds, other Middle Eastern-backed capital is active in Hong Kong and A-share IPO cornerstones and private placements. - A/H Share Holdings: Holdings are estimated at approximately $13.5 billion, favoring leaders in new energy, advanced manufacturing, and tech, alongside traditional resources. Based on FactSet data, institutions registered in Middle Eastern countries hold around $13.5 billion in Chinese stocks. The largest holder is CYVN Investments. Considering only top 10 holdings are reported, actual sizes are likely larger. Analyzing major institutions like ADIA and KIA reveals preferences for leaders in materials, technology hardware, capital goods, and specific manufacturers. In summary, the investment logic of Middle Eastern sovereign funds in Chinese assets extends beyond traditional resources to include: 1) New Energy: Globally competitive leaders aligning with the Middle East's energy transition needs; 2) Advanced Manufacturing: Leveraging China's manufacturing strength and import substitution dividends; 3) Technology: AI infrastructure, applications, and hard tech, consistent with their global tech allocation strategy.
Could Middle Eastern capital selling cause impact? No short-term signs; depends on fiscal pressure from prolonged Strait of Hormuz tensions. Beyond potential inflows, Middle Eastern capital holds substantial other assets, like U.S. Treasuries and stocks. In extreme scenarios, fiscal revenue pressure could trigger asset sales, causing secondary risks. How to assess potential selling pressure? Major Middle Eastern oil producers' fiscal revenues are highly dependent on oil exports. Analyzing potential revenue shortfalls from a prolonged Hormuz Strait disruption suggests a significant annual "gap." However, current foreign exchange reserve levels suggest the capacity to manage such a gap for several years without immediate asset sales. Short-term EPFR data shows marginal outflows from U.S. stocks and bonds, but the scale is modest. Historically, during past oil crises, Middle Eastern holdings of U.S. Treasuries saw declines, but recovered afterward. During the recent tariff episode, reductions were minor.
Conclusion: Short-term inflows are limited and may not enter stocks; long-term diversification and industrial investment demand exists. In summary: 1) Short-term: Some external capital domiciled in the Middle East might flow back for hedging, but data across dimensions suggests the scale is currently limited and may not directly enter the stock market. 2) Medium-to-long term: Local Middle Eastern capital may still increase Chinese asset allocations driven by diversification needs and industrial investment logic, utilizing Hong Kong's financial hub. This would be a longer-term, more focused investment in core assets like new energy, advanced manufacturing, key resources, and tech leaders, aligning with diversification, industrial transformation, and long-term value investment needs. Additionally, the risk of asset sales causing secondary impacts, should conflicts prolong and create significant fiscal pressure for Middle Eastern states, warrants attention.
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