TitleSenior Investment Analyst
DateMay 29, 2018
China’s shadow over the Asian and Emerging Market universe is set to lengthen, albeit modestly, with the forthcoming inclusion of mainland Chinese shares in the dominant reference benchmarks. Shailesh Jain and Steven Sweeney take a look at the A-shares segment and explore the likely impact on the universe, including implications for investors.
Chinese A-shares trade in renminbi (RMB) on two Chinese exchanges: the Shenzhen Stock Exchange (SZ) and the Shanghai Stock Exchange (SSE). Historically, China A-shares enjoyed only limited accessibility, and it was not until 2003 that they were available to foreign investors via the Qualified Foreign Institution Investor program, which also came with a number of restrictions. The introduction of the Shanghai-Hong Kong Stock Connect in 2014 was a key milestone in facilitating MSCI Index inclusion.
While international investors are familiar with, and have direct access to, the offshore China equities (or China ‘H’ shares), many have only a broad understanding of the domestic ‘A’ share market, which has its own internal dynamics. China ‘H’ shares, which are Chinese companies listed in Hong Kong and freely accessible, currently make up about 28% of the MSCI Emerging Market and Asia ex-Japan Indices.
MSCI announced it will add 234 Chinese A-shares in June and September 2018, with an initial weighting of only 0.39% within the Emerging Markets Index, rising to 0.73% in September. The inclusion factor will increase gradually over coming years, leading to a higher index weight. The Chinese A-share market is highly liquid and the second largest equity market after the New York Stock Exchange (NYSE). Among the larger and more topical names to be included in the index are Industrial and Commercial Bank of China (ICBC), China Construction Bank, Petro China, and white spirits distiller Kweichow Moutai.
MSCI Index breakdown by market
Source: Lonsec, MSCI
The Chinese A-share market consists of Shanghai (SS, CSI300) and Shenzhen (SZ, SZSE100) listings. The SSE is China’s largest exchange, representing a total market capitalization of AU $6.76 trillion in September 2017. The SSE is located in Shanghai—China’s financial capital—and most of the companies listed are the large, state-owned companies responsible for China’s economic growth. The SZ is a smaller exchange, with a market capitalization of AU $4.63 trillion in April 2018. It is located in Shenzhen, Guangdong—one of China’s most modern cities. The market consists of growth-oriented stocks in the information technology, consumer and industrials sectors.
The composition of sectors in the Emerging Markets index will change with the inclusion of Chinese A-shares, because the domestic stock market is more representative of China’s transitioning economy. For example, consumer and other domestic-led companies such as financials, industrials and healthcare form a bigger part of the A-share index, while energy and technology hardware sectors have a smaller representation. Hence the inclusion of A-shares will offer greater direct exposure to domestic structural trends in China.
Chinese A-share performance versus the world
Source: Lonsec, Bloomberg. As at 30 April 2018
MSCI Index period returns (% p.a.)
|1 year||3 years||5 years||7 years||10 years|
|MSCI China A Onshore NR Index||7.76||-10.06||14.67||7.94||7.94|
|MSCI China NR Index AUD||34.02||6.51||18.38||12.40||6.80|
|MSCI Emerging Markets NR Index AUD||20.58||7.56||11.63||7.51||4.46|
|MSCI World NR Index AUD||12.17||9.13||16.46||14.08||7.84|
Source: Lonsec, Bloomberg. As at 30 April 2018
In the meantime, MSCI has highlighted several factors which, if improved, could drive further accessibility to A-shares over time. These include:
• Better alignment of the A-share market with international market accessibility standards
• A more resilient Stock Connect programme
• Relaxation of daily trading limits
• Continued progress on trading suspensions, and
• Further loosening of restrictions on the creation of index-linked investment vehicles.
In 2015 and 2016, huge price swings made China’s stock market look like a casino. One reason for Chinese volatility is that the market is thinly traded, since only 7% of China’s population owns stocks. Since participation is so low, around 80% of tradable shares are in the hands of a wealthy few, whose investment decisions drive the price swings in the Chinese market.
CSI 300 Index (value of $10,000 invested to April 2018)
Source: Lonsec, Bloomberg
MSCI has been cautious and measured in its approach to inclusion of mainland Chinese shares, and rightly so. Traditionally the hunting ground for retail investors, A-shares have experienced higher volatility than other regional indices. The higher incidence of trading suspensions in individual companies by authorities has also been an unwelcome consideration for investors to contend with. For example, over half of all A-shares were suspended in July 2015 when volatility spiked and the market sold off.
Transparency of company strategy, financial operational reporting, and corporate strategy are also often less clear in companies where the Chinese state is a major owner or lead influencer in determining business prospects. Corporate governance is a heightened risk in many companies, with either little ESG awareness or unsophisticated reporting on ESG matters. These factors are likely to improve over time with more foreign shareholders driving progress, but in the interim favour those investors who take a heightened focus on due diligence and look to uncover many rocks and kick many tyres in the research process.
As the second largest equity market in the world finally opens up to foreign capital, it is clear that investors can no longer ignore it. This is consistent within the Lonsec universe, where most managers have resourced up or are looking to add resources with specialist A-shares experience. These managers often have established research offices in Shanghai, Shenzhen, Beijing and elsewhere.
Clearly, China will become an increasingly important component of the investment universe within Asian and emerging markets more broadly. This segment is under-researched in Lonsec’s view and favours investment managers with the right knowledge, resources and investment processes that enable them to cover the A-share market effectively. Lonsec believes that greater institutional ownership of these stocks will also serve to improve the shareholder experience and drive stabilised performance outcomes from a segment characterised by sharp selloffs and rallies.
IMPORTANT NOTICE: This document is published by Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL 421 445 (Lonsec).
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