From today, China’s domestic companies are going to be more relevant for IFAs and their clients.
MSCI, the world’s largest stock index provider, has for the first time agreed to include the country’s mainland domestic stocks in one of its key indices.
China’s A shares, some 222 companies, will now be added to the MSCI Emerging Markets Index.
So, like it, or not (and there are worries about the transparency of some Chinese companies), these stocks are now on our radars.
Bill Maldonado, CEO, Asia Pacific, HSBC Global Asset Management, said: “The newly announced decision by MSCI to include China A-shares signals a significant step in the opening up of Chinese capital markets to international investors, in a coordinated and controlled manner. While the inclusion is unlikely to be the catalyst that sparks a re-rating of the market in the short term, it is conducive to capital inflows to the onshore equity market in the long run.
“As the global economy shifts from West to East and China continues to progress its RMB internationalisation agenda, more international investors will recognise the immense investment opportunities China offers and gradually start getting and increasing exposure to the country in their diversified portfolios. The Chinese equity market offers unique opportunities across sectors including technology and ‘new economy’ stocks which we believe are key growth contributors to our Chinese equity portfolios. ”
Analysts Mike van Dulken and Henry Croft at Accendo Markets told their clients this morning: “MSCI finally including some China mainland stocks (A-shares) in its indices, thereby obliging $1.6tn of tracker funds to hold the shares, has done little to boost investor mood. It had been on the cards for years, many of those included were already available via the new HK trading links and they will still only represent a small portion (0.7%) of MSCI’s flagship index.”
Aidan Yao, Senior Emerging Asia Economist at AXA Investment Managers (AXA IM) said: “After three failed attempts, MSCI finally granted China’s A-shares the membership to its global equity indices. Although only a symbolic event – insofar as its influence on near-term capital flows is concerned, symbolism matters for China’s retail-dominant market (via its impact on sentiment) and the Chinese leaders, who will see this as another milestone for financial liberalisation.
“Together with RMB’s inclusion in the Special Drawing Right (SDR) and future inclusion of China bonds in global fixed income indices, we think today’s MSCI move will help to accelerate China’s financial integration into the rest of the world. For global investors, while the inclusion will not trigger an immediate and wholesale change in their asset allocation, it will put Chinese equities on the map. Ignoring this market will become increasingly difficult, as Chinese assets are making their way into global benchmarks.
“Below we discuss the key issues relating to the MSCI inclusion in more details:
- Why a positive verdict this time? Both sides – MSCI and China – made considerable efforts to make the inclusion possible. On the China side, the authorities have made large strides towards improving investors’ market access, reducing stock suspensions and (reportedly) offering some concession on the preapproval requirement. At the same time, MSCI also reduced the number of stocks for inclusion to 222 large-caps, which are available on the stock connects and have minimum trading-suspension history.
- How will inclusion proceed from here? The official inclusion will be carried out in two steps, coinciding with MSCI’s May and August 2018 index reviews. At the start, only 5% of A-shares’ full weight will be included, considering the daily trading capacity of the stock connects. MSCI stated that if the trading limits are raised or abolished, the full inclusion could proceed more swiftly. In the interim, MSCI has created a few provisional indices – for example, the MSCI China A International Large Cap Provisional Index is launched today – to ease the transition for investors.
- Why a symbolic importance? For two reasons:1) the official index inclusion will not take effect until a year later, so there is no immediate need for any investors to change their portfolio allocation. 2) Even as the new index takes effect, only 5% of A-shares’ full weight will be reflected initially, which translates to only 0.1%, 0.7% and 0.8% addition to the MSCI All Country World Index (ACWI), Emerging Market and Asia ex Japan indices (see charts below). This, by our estimate, will usher in a total of USD16bn inflows to A-shares, which accounts for less than 1% of China’s A-share market cap, and a fraction of its daily trading volume (averaging 50-70bn over the past year).
- Why symbolism can still matter? Despite a small influence on capital inflows at the start, we think the MSCI inclusion can still have positive impact on the market. In the near-term, retail investors, who dominate A-shares trading, could be buoyed by the decision. The CSI 300 – China large cap index – is currently up by 0.5% against a sea of red in other regional markets after the overnight selloff in Developed Markets (DM) equities. The long-term implication could be more significant. Greater foreign investor participation could improve A-share’s market composition, quality of corporate monitoring, regulation and reporting standards. Volatility and speculation could also decline, as the market shifts from short-term retail flows to long-term institutional flows.
“For Beijing, the MSCI decision will be seen as another recognition for China’s financial liberalization. Together with RMB’s entry into the SDR and future inclusion of China bonds in global indices, the MSCI move could encourage the Chinese leaders to speed up capital market development. We are at the initial stages of China’s financial integration into the global system, whose impact could be as powerful and profound as its economic integration in the past decades.
- What are the implications for global investors? Even though most (non-passive) investors are likely to stand pat, the MSCI inclusion will help put A shares on their radar screen. As Chinese equities, bonds, currency enter into global benchmarks, investors can no longer ignore China as they used to, because doing so will have an impact on their relative performance.
“As it currently stands, Chinese equities are not unattractive from a valuation (Shanghai trades at 16 times PE) and earnings growth perspective. With macro condition stable and RMB actually appreciating lately, investing in Chinese stocks does not seem like a bad trade. Longer-term, however, the market outlook will depend on how the structural imbalances in the economy can be resolved by reforms.
“We are encouraged by the recent progress on financial deleveraging, as it shows that Beijing is committed to do what’s needed despite the short-term pains. We think the pace of reforms could accelerate after the leadership transition in the fall, and such is needed to underpin our cautiously constructive outlook on the Chinese economy/market over the medium to long term.”