Initial public offerings offer silver lining to investors

Chinese mainland stocks may be tumbling at the fastest pace in seven years, but one part of the $5.2 trillion market is hotter than ever: initial public offerings.

The six mainland companies that took bids from IPO investors over the past two weeks attracted orders worth 7.1 trillion yuan ($1.1 trillion), more than the value of Australia's entire equity market.

The offerings－the first under new rules that allow investors to bid without making upfront deposits－were oversubscribed by more than 1,800 times on average.

Now that IPO orders no longer tie up cash, the deals have turned into the equivalent of lottery tickets that only require buyers to pay if they hit the jackpot. Gains are seen as virtually assured because regulators have capped IPO price-to-earnings ratios at levels less than half the median valuation on mainland exchanges, a ceiling that led to average one-month returns of 383 percent last year. While odds of securing an allocation are minuscule, the prospect of outsized profits is proving hard to pass up as investors try to recover from last month's 23 percent plunge in the Shanghai Composite Index.

"Returns are guaranteed," said Wang Zheng, the Shanghai-based chief investment officer at Jingxi Investment Management Co. "That's why everyone is so willing to participate in bidding and demand for new shares is so high."

The valuation cap－at 23 times earnings－is one of many market distortions introduced by Chinese authorities in their effort to protect individual investors in one of the world's most volatile equity markets.

The government has also ordered State-linked funds to buy stocks, clamped down on futures trading and restricted stake sales by major shareholders.

"The 23 times P/E ratio is a line no one dares to touch now," Wang said. "The regulator will conduct 'window guidance' should anyone overstep it."

China's securities regulator said in December it would no longer require investors to pay upfront for IPOs, a rule that had been wreaking havoc on liquidity conditions in the nation's financial system. Almost every time a new batch of companies took orders over the past year, money-market rates climbed and the Shanghai Composite slumped as investors hoarded cash for their bids.

"The good thing about the new IPO system is that it won't cause wild swings in liquidity," said Wei Wei, an analyst at Huaxi Securities Co in Shanghai.

For the six deals priced under the new system, odds of getting an allocation were 0.05 percent, according to data compiled by Bloomberg from exchange filings. That compares with about 0.5 percent under the old rules.