Global markets experienced a wild ride in 2019, caused by the uncertainty surrounding trade talks, the Hong Kong protests, and its’ declining rate of GDP growth. Throughout this, China has remained in the spotlight of the world market. The long-disputed US-China trade war has recently tapered off after the phase one trade deal was signed. Now as we enter 2020, the coronavirus outbreak in Wuhan again puts China back in the limelight. Recent events are stark reminders that the unexpected could happen at any time, and that portfolio diversification is critical.
Given recent events, perhaps it’s time to pay more attention to China, the world’s second largest economy.
China has accelerated efforts to diversify its economic model, by moving away from a manufacturing-based economy and diversifying into services and consumption. Consumers have played an important role in supporting China’s ongoing transition to a growth model, which has made it more reliant on the aforementioned factors, and less on investments and manufacturing.
In addition, the MSCI A-share inclusion serves as a testament to China’s increasing influence. The weight of A-shares has risen to 3.3% of the MSCI Emerging Markets Index since November 2019.
MSCI A-shares inclusion
MSCI indices are one of the most popular benchmarks for investment in global equity markets. In 2019, MSCI completed a three-step weight increase for China A-shares in the global index. The inclusion factor started at 5% in step one, increasing to 20% by step three. The weight of A-shares has risen to about 4% of the MSCI Emerging Market Index, from less than 1% prior to the inclusion announcement. In the event of full inclusion, as MSCI projected, China A-share would exceed 16% of the MSCI EM Index. This means that China’s equities (off-shore and on-shore) would exceed 40% of the MSCI Emerging Markets Index.
What does this mean for global investors?
1. A broader investment opportunity in mainland China
The MSCI index not only increased the inclusion factor, but also added mid-cap and ChiNext shares to the list, as well as large-cap names. This broader market inclusion is more representative of the China-A shares market. Investors may be optimized to benefit from the influx of foreign investments into a specific subset of A-shares. In the long run, the representation of foreign investment in the China A-shares market will continue to rise.
2. The Continued Evolution of China’s Capital Markets
MSCI’s inclusion may serve as a symbolic move for international recognition of China’s market liberalisation. China has been increasing efforts to make its capital markets more accessible, through quota increases for QFII (Qualified Foreign Institutional Investors) and RQFII (RMB Qualified Foreign Institutional Investors), and the HKEX Stock Connect programmes for Shanghai and Shenzhen-listed stocks. These initiatives have facilitated access to China’s A-shares market for foreign investors. In the future, a steady inflow of institutional money is expected as well.
3. The Growing Presence of Foreign Investors in China
For quite some time, global fund managers have continued to shun China A-shares. Instead, they have used China-related stocks, such as Hong Kong’s H-shares, or Chinese companies listed in New York, as proxies to invest directly into China. Now, the global investment community, which tracks MSCI indices, will be more obliged to invest in A-shares. Foreign investors, especially institutional investors, are more focused on the long-term, and will be the cornerstone of investment capital in the China A-share market. This will, in turn, reduce market volatility and cultivate more rational investing.
How Can Interested Investors Participate?
- Understand the constituents of the Chinese equity market:
- Offshore market – Chinese companies listed in HK and New York
- Onshore market – Chinese companies listed in Mainland China (China A-shares)
- Be on alert for potential MSCI China A-share Further Inclusions
- Indirectly invest in China A-shares through emerging market ETFs or mutual funds
- Directly invest in ETFs tracking onshore China A-shares based on market capitalization
- CSI 300 index – Consists of the 300 largest and most liquid A-share stocks (large-cap).
- CSI 500 index – Consists of the largest remaining 500 A-shares (small-mid cap).
- ChiNext Index – Consists of the 100 largest and most liquid A-shares listed on the ChiNext Market of the Shenzhen Stock Exchange. It consists of innovative businesses and emerging industries, and is considered to be like a “Chinese Nasdaq.”
China’s market valuation is relatively low, compared with that of developed markets. That said, the uncertainty of the economic impact from the coronavirus and potential future geopolitical conflicts, does warrant caution when investing in this region. Long-term growth-oriented investors should speak to their advisor about revisiting their asset allocation, and review whether it would be appropriate to include emerging markets or Chinese companies. Investing in China may not be suitable for all investors. However, even those who do not own Chinese stocks directly should still pay attention to its market developments. As the second-largest economy in the world, its’ sheer size has the ability to influence investment sentiment and the global market direction as a whole.