China’s index presence to grow
This week, MSCI announced a decision to introduce China A-shares into its emerging market index from June 2018. China A-shares are stocks listed in Shanghai and Shenzhen and only a small proportion of A-shares have been available for foreign investment due to China’s closed capital account. These are distinct from H-shares which represent Chinese companies listed on the Hong Kong Stock Exchange which are traded freely.
Chinese A-shares entering the MSCI Emerging Markets Index will be a significant further step in the growing role of China in the emerging market equity asset class. Whilst the initial weighting in A-shares will be low (currently earmarked at 0.73% of the overall index), and many large A-shares also have dual H-share listings and are already in the MSCI Emerging Markets Index, this move reinforces China’s position as the largest country in the asset class.
We see both opportunities and risks for investors in emerging markets from A-share inclusion. On the one hand, it opens up some important and impressive Chinese companies for index-aware investors. Examples would include Kweichai Moutai, a spirits producer with a market capitalisation of US$87 billion, and BOE Technology Group, the rapidly-growing display technology company, whose revenues have grown by a factor of ten in under eight years. We continue to foresee strong growth in the consumer and services side of the Chinese economy, and new opportunities to access these would be a very positive development.
However, A-share inclusion would result in an even greater index weight in Chinese financial and real estate stocks (currently 6.7% of MSCI Emerging Markets Index, almost twice as large as Mexico). Many observers are (we feel, correctly) concerned about the recent growth in credit in the Chinese economy. Chinese financial stocks have de-rated aggressively in recent years, seemingly as investors share that concern about the health of the financial system. A-share inclusion would increase that exposure, particularly for passive investors.
Overall, we would see the inclusion of A-shares into the MSCI Emerging Markets Index as an exciting opportunity to access growth in the Chinese economy, but also as a reminder of the importance of investing selectively within the asset class rather than buying complete index exposure. We do not currently have A-shares in the portfolio, but our stock selection process includes the larger A-shares in our China stock universe.