To The Moon

An analysis of mainland mutual fund holdings for the second quarter of 2026 reveals a proactive reduction in Hong Kong stock exposure, with their share of overall southbound investment also declining. In terms of sector allocation, semiconductors and technology hardware saw the largest increases, while media & entertainment, energy, and e-commerce sectors experienced significant drops. Reviewing the first half of 2026, the weakness and divergence in the Hong Kong market essentially reflect the direct impact of a K-shaped divergence in the credit cycle. For Hong Kong stocks to genuinely break out of their trough, stronger catalysts are still required. Based on an assessment of "phased rotation" within a structural market, two key investment themes are suggested: first, technology remains the primary focus but requires catalysts; second, if concerns exist about the slow materialization of catalysts in the tech hardware sector, investors can moderately focus on sectors with relatively smaller fundamental headwinds as options for rotation and balanced portfolio allocation. The key findings are as follows:

Overall Investable Scale

The total scale of mainland mutual funds eligible to invest in Hong Kong stocks increased quarter-on-quarter, although the scale of new fund launches slowed compared to the previous quarter. As of Q2 2026, there were 5,163 mainland-domiciled mutual funds (excluding QDII) eligible to invest in Hong Kong stocks, with total assets under management (AUM) reaching 4.4 trillion yuan. This represents an increase of 307 funds from Q1 2026, with AUM rising by 465 billion yuan quarter-on-quarter. These funds account for 33.4% of the total 15,418 non-money market funds and 18.4% of their total 23.9 trillion yuan AUM. Among these, there are 2,640 actively managed equity-focused funds (total AUM 2.4 trillion yuan), an increase of 124 from Q1 2026, with their overall AUM rising by 470.6 billion yuan. Regarding new issuances, the number of new Hong Kong-eligible mutual funds launched in Q2 2026 accelerated compared to Q1, with a total of 307 new funds. However, the scale of new issuance decreased from the previous quarter to approximately 220.2 billion yuan (compared to 263 funds and 249.3 billion yuan in Q1 2026). The same trend was observed for actively managed equity-focused funds: the launch pace accelerated with 124 new funds, but the new issuance scale slowed to 77.8 billion yuan (compared to 109 funds and 107.2 billion yuan in Q1 2026).

Holdings Overview

In terms of holdings, mainland mutual funds actively reduced their Hong Kong stock positions in Q2 2026. The proportion of their holdings has fallen below the level seen in Q2 2024, and their share of the overall southbound investment pool also declined. The Hong Kong stock holdings of the aforementioned mutual funds totaled 649.1 billion yuan, a decrease of approximately 23% from the 842.1 billion yuan held in Q1 2026. Considering that the Hang Seng Index and MSCI China fell by 7.7% and 7.6% respectively in Q2 2026, this indicates proactive selling by mutual funds. As of Q2 2026, the proportion of Hong Kong stock holdings in the total equity investment value of these mutual funds declined to 23.3%, below the 23.9% level in Q2 2024 and significantly lower than the 34.7% in Q1 2026. Looking specifically at actively managed equity-focused funds, their Hong Kong stock holdings in Q2 2026 amounted to 311.3 billion yuan, a 14.4% decrease from the 363.9 billion yuan in Q1 2026. The proportion of their holdings dropped from 22.5% in Q1 2026 to 15.1%, falling below the 2023 level. During this period, the proportion of mutual fund holdings within the total 5.2 trillion yuan southbound investment pool also declined, decreasing by 2.2 percentage points from 14.7% in Q1 2026 to 12.5%.

Sector Allocation

Semiconductors and Tech Hardware Holdings Reach Historical Highs, Internet Holdings Drop to Lows

Semiconductors and technology hardware saw the largest increases in holdings, while media & entertainment, energy, and e-commerce sectors experienced the most significant declines. On a quarterly change basis, the proportion of holdings in "old economy" sectors decreased from 31.3% in Q1 2026 to 20.6% in Q2, slightly above the levels seen in the first three quarters of 2025. Concurrently, the proportion of holdings in "new economy" sectors rebounded from 68.7% in Q1 2026 to 79.4%. Breaking it down, semiconductors, technology hardware, and equipment saw the largest increases in their share of holdings. Conversely, media & entertainment, energy, and e-commerce saw the largest decreases. In terms of overall holding proportions, semiconductors, technology hardware & equipment, and pharmaceuticals ranked highest. Sectors such as commercial & professional services, consumer staples, and utilities had relatively low holdings. Compared to their own historical levels, sectors like semiconductors and technology hardware & equipment are now at historical highs, while most other sectors are at historical lows.

Outlook and Prospects

Reviewing the first half of 2026, the weakness and divergence in the Hong Kong market essentially reflect the direct impact of a K-shaped divergence in the credit cycle: while technology and external demand remained strong and credit continued to expand, the household credit impulse had already retreated to pre-"September 24" levels. Coupled with a cooling in southbound flows, capital diversion by foreign investors, and funding "tightness" due to concerns over Federal Reserve tightening, the overall performance of Hong Kong stocks significantly lagged. This pattern is corroborated by changes in positioning: in Q2 2026, mainland mutual funds actively reduced Hong Kong stock holdings, structurally selling down traditional heavyweights like TENCENT and BABA-W while clustering around semiconductor and AI hardware leaders like SMIC and HUA HONG GRACE. This aligns with the global trend of capital chasing the AI theme. However, entering July, highly crowded global AI assets experienced "deleveraging-style" turbulence amid bubble fears, with adjustments seen in South Korean stocks, U.S. tech, and China's ChiNext board. This, in turn, created a phased trading opportunity for Hong Kong stocks, which were at low valuations and positioning levels, leading to a rebound in some consumer and internet sectors and signs of phased rotation within the structural market.

Looking ahead, how will the structural market conclude? Reviewing historical cycles like the Nifty 50 (2016-2018), semiconductors (2019-2020), and new energy vehicles (2021-2022), the ultimate outcomes of structural markets are limited to three scenarios: diffusion, collapse, or rotation. The analysis suggests that conditions are currently not ripe for either broad diffusion or overall collapse. Diffusion requires synchronized expansion in both fiscal and private credit, a high threshold. Although the broad fiscal deficit impulse may see marginal improvement in Q3, the overall incremental fiscal support for the year remains limited and primarily aimed at providing a floor. The household credit impulse is unlikely to recover rapidly in the short term, making it difficult for the K-shaped divergence to converge quickly. A collapse would require a systemic disproval of the AI industry trend, but demand is still expanding. The return on invested capital (ROIC) of major cloud providers remains above their weighted average cost of capital (WACC), and starting leverage is significantly lower than during the dot-com bubble era. AI remains a relatively certain expansion direction within the credit cycle. Therefore, a more likely scenario is phased rotation: the credit expansion logic of the AI theme remains intact. Short-term adjustments, in fact, help release crowding and valuation pressure, improving risk-reward. If subsequent catalysts like earnings, product launches, or policy support emerge, capital is likely to return to the original theme.

For Hong Kong stocks themselves, stronger catalysts are needed to truly emerge from the bottom. Comparing multiple dimensions such as the extent of adjustment, valuation, risk premium, earnings, capital flows, and sentiment with historical bottoms reveals that, at the index level, there is still a gap from historical troughs, and no clear signals of a comprehensive earnings clearance have emerged. However, indicators like the valuation of some heavyweight stocks, the allocation ratios of domestic and foreign capital, and share buybacks have become quite extreme. It must be emphasized that low valuations alone are insufficient to sustain a rebound. For Hong Kong stocks to truly break out of the bottom, stronger catalysts are required: either fiscal stimulus akin to the "September 24 moment" or a technological breakthrough similar to a "DeepSeek moment." In the short term, positive developments in the following areas could provide support for Hong Kong stocks: First, the realization or alleviation of Federal Reserve tightening expectations. Current market concerns about rate hikes are already largely priced into assets; even if subsequent hikes materialize and expectations are realized, their marginal impact may be limited. If tightening concerns ease further, it would benefit rate-sensitive assets like the Hang Seng Tech Index and innovative pharmaceuticals from a discount rate perspective. Second, potential capital rebalancing driven by the extreme underweight positioning of both domestic and foreign investors in Hong Kong stocks, especially against a backdrop of increased tech volatility. Third, marginal changes in domestic policy. Although a significant policy ramp-up or a clear shift is unlikely, fiscal support in Q3 may see a slight improvement compared to Q2.

Portfolio Strategy

Regarding portfolio allocation, based on the assessment of "phased rotation" within a structural market, two key investment themes are suggested: First, technology remains the primary focus but requires catalysts. The AI industry trend has not been systemically disproven. As a typical asset class with high win probability but low risk-reward, timing is as crucial for entering at low levels as it is for reducing exposure at high levels. The difference lies in the fact that entering early may face further drawdowns, while entering later may miss part of the rebound. Short-term adjustments actually help release crowding and valuation pressure, improving the risk-reward profile. Subsequently, three aspects warrant close attention: liquidity risks arising from leveraged trading and concentrated selling, interest rate path information provided by the late-July FOMC meeting, and whether the industry logic can gain new momentum from earnings catalysts. Second, if concerns exist about the slow materialization of catalysts in the tech hardware sector, investors can moderately focus on sectors with relatively smaller fundamental headwinds as options for rotation and balanced portfolio allocation. Risk-reward and win probability calculations indicate that, at the asset level, the Hang Seng Tech Index already offers relatively attractive risk-reward. At the sector level, consumer and internet sectors already possess high risk-reward, while innovative pharmaceuticals show relatively favorable combinations of both risk-reward and win probability. From a positioning perspective, the fact that mainland mutual fund holdings of Hong Kong stocks in Q2 2026 returned to pre-"September 24" levels, with internet holdings at historical lows, also provides some risk-reward support for the aforementioned directions. Of course, the realization of favorable risk-reward ultimately depends on fundamentals: recent sharp fluctuations in some heavyweight stocks illustrate that relying solely on low valuations and low positioning is insufficient to weather periods of risk aversion. Only a tangible improvement in fundamentals can genuinely increase the win probability and open up space for a sustained uptrend.