Investment Strategies

After MSCI's Big China Decision, Wealth Managers Take Stock

Tom Burroughes Group Editor 26 June 2017

After MSCI's Big China Decision, Wealth Managers Take Stock

Asset allocators may have been wary of mainland China equities in recent years but staying aloof has got harder after the indexing organisation took a major step last week. Wealth managers reflect on the development.

Last week Morgan Stanley Capital International decided it will include Chinese A-shares into its global equity benchmarks, a move that has been hailed as a major vote of confidence in mainland Chinese equities. MSCI began to consider this move in 2014 when it carried out its first full review of the country’s eligibility. With MSCI taking such a step, it opens the way for wealth managers of all kinds, as well as retirement schemes, foundations and other organisations that might not previously have been able or willing to hold such assets to do so. And this move comes on top of steps taken in recent years to open China up to international capital, as well as promote use of its renminbi currency (such as the IMF’s inclusion of the currency in its Special Drawing Rights system).

A few days have elapsed since the MSCI decision. With time to reflect, here are comments from various wealth management firms and other financial institutions about what has happened.

Bank of Singapore
While positive for sentiment, the initial market impact is limited with China A-shares accounting 0.73 per cent of the emerging market index based on initial 5 per cent inclusion factor. Market estimated inflows range from $2-3 billion for passive flows and $10-12 billion for active flows from rebalancing compared to average $65 billion daily trading turnover in year-to-date 2017. Longer-term, China A-shares could account for around 9 per cent of the EM index while overall China (including HK-listed and ADRs) could account 34 per cent. (ADR is American Depository Receipt.)

Goldman Sachs Asset Management
This is a watershed event. We believe China’s strategy is to create more portfolio inflows into the country, which may help balance capital outflows - the world diversifies into China as China diversifies outward. Inclusion of A-shares in global equity benchmarks are a critical step in the process. In the near-term, portfolio inflows are likely to be modest given the limited initial A-shares weighting of 0.73 per cent in the MSCI Emerging Market Index (China’s total country weight is 27.7 per cent counting all share classes).

If China continues its market reform, that weighting could grow significantly over time: on full inclusion, MSCI estimated an 18.2 per cent weighting for A-shares and more than 35 per cent for China overall. Full inclusion could take a number of years given the size of China’s market and the constraints on market access capital mobility that still need to be addressed. But we believe inclusion in global equity indices is a major step in China’s longer-term strategy and that inclusion of China’s bonds in global fixed income indices will be another important step.

China’s domestic demand should become a bigger driver of EM equity markets. The broader A-shares market and the initial 222 stocks to be included into MSCI indices remain tilted towards “Old China”, including manufacturing and state-owned enterprises. Over time, the “New China” segments of the market—those oriented to the strengthening consumer, rapidly aging population, and continuously evolving domestic consumption patterns—may grow, both in terms of their share of China’s equity market and their influence on broader EM equity market performance.

China’s domestic equities offer a unique combination of potential opportunity and risk. Global investors have generally focused on China’s offshore H-share market rather than the domestic A-shares market. Investors should be aware of the heavy weighting of SOEs in the A-shares market. Many SOEs have significant debt and operate in segments of the economy that could be at risk of overcapacity. On the other hand, China’s domestic market includes a huge number of small- and mid-cap stocks that are often not included in major benchmarks. We continue to focus on companies with robust organic demand growth, credible long-term business strategies, and sound management execution and we see attractive potential opportunities in the health care, information technology, and consumer sectors at the company level.

Jack Lee, head of China A-Share research at Schroders
It is now an opportune time to include A-shares in the MSCI Emerging Markets Index, as foreign investors have begun having a better understanding of the market following the launch of the Shenzhen-Hong Kong Stock Connect last year.

The significance of the inclusion does not lie in the immediate capital inflow, as it will typically take approximately one year to implement the inclusion. However, it points to China A-shares becoming a key feature of emerging markets and part of the asset allocation consideration set for global investors.

East Capital
The MSCI Inc. decision on China was not a big surprise to us. MSCI has recognised that a number of significant improvements have been made over the last 12 months, especially as far as accessibility is concerned. Shenzhen Connect was launched 6 months ago and in relation to this launch, the aggregated quota was removed. Rules regarding stock suspension which had been made both clearer and stricter, have been properly implemented. The requirement to get pre-approval by local stock exchanges to issue A-shares products such as ETFs (“Anti-competitive clause”) has been loosened and is now considered as a minor non-blocking point by MSCI.

MSCI on its side also made some significant changes in its proposal. Focusing only on large capitalisations accessible via the Connect and automatically removing stocks that have been suspended for more than 50 consecutive days during the previous 12 months at each rebalancing, MSCI is reducing the eligible number of stocks from 448 to 222 stocks (versus the 169 initially suggested on March 23, as they decided to add dual listed shares). The targeted initial weight of China A-share names in the MSCI EM index will be 0.73 per cent a year from now versus 1.5 per cent considered in the past. Reducing overlap with marginal weights and keeping the initial benchmark universe to a reasonable size to improve investability and ensure liquidity have been key to reach a positive decision.

Bank of America Merrill Lynch
This is a milestone for the globalisation of the A-share stock market, in our view. However, given the long road to full inclusion, the moderate size of inflows relative to A-share market cap, we do not expect the announcement to provide much beyond a short-term sentiment boost for the broad A-share market. That said, potential impact on some good quality A-shares on the inclusion list may be more pronounced and lasting. Chinese brokers, including those listed in HK, may also benefit moderately from a potential pick-up of Stock Connect volume. On the other hand, existing MSCI constituents, including ADRs [American depositary receipts], US-listed Chinese tech names and A/H dual-listed large cap H shares, may suffer marginally from a diluted weighting.

Allianz Global Investors
A key reason for inclusion was the much improved accessibility for global investors of China’s two stock exchanges in Shenzhen and Shanghai. Following the launch of the Shenzhen Stock Connect scheme in Dec 2016, and combined with the equivalent Shanghai launch in 2014, more than 90 per cent of MSCI China A Share constituents are directly accessible without the use of cumbersome QFII quotas.

Inclusion in widely-followed global indexes means that an investment in China A shares moves from off-benchmark (and therefore can be easily ignored) to an active asset allocation decision. As the weight in indexes increases over time – as has been the experience in other emerging markets – then increasingly China A shares are likely to become too big to ignore for much longer.


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