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Rebalancing flows in focus after MSCI call on A-shares

Rebalancing flows in focus after MSCI call on A-shares

MSCI’s announcement that it will include China A-shares in its emerging market benchmark last week has triggered a heated debate about just how the decision will impact other emerging markets.

The Chinese equity market is the second largest in the world, with a market capitalisation of $7.7 trillion, although it remains underrepresented in major global indices. MSCI said last Tuesday that it would gradually begin to include A-shares, initially with a low weighting.

By next August, MSCI will add 222 China A-share large-cap stocks to the index, representing 0.73% of the benchmark, with an inclusion factor of 5%. Ultimately, A-shares could make up as much as 20% of the benchmark, not counting the existing overseas Chinese company weighting of 27%.

The MSCI emerging market index is tracked by more than $1.5 trillion worth of assets under management, and a more substantial inclusion would mean that a lot of capital would flow into A-shares — up to $300 billion, according to Old Mutual Global Investors.

But where that money comes from matters. Some analysts predicted that China’s inclusion could be to the detriment of other emerging markets, others said that the decision was net positive for EMs in general. Last Wednesday Reuters article, quoting an unnamed government official in Korea, said that there could be outflows of KRW 4.3 trillion ($3.8 billion) from the Korean markets as a result of the changes to the index.

‘The figure is probably a bit scary,’ said Jeik Sohn, investment director, Asia at M&G Investments. The Korean stock exchange has had a relatively good year, and remains undervalued.

‘From a short-term perspective, money for investing A-shares will come from passive investors, who will be forced to add China A-shares to their portfolios,’ Sohn said, adding that active investors are concerned about investing in China A-shares at the moment, due to questionable corporate governance standards and difficulties in access for foreign investors.

If those standards improve, active investors will come into the market in greater force, he said.

Caroline Yu Maurer, head of Greater China equities at BNP Paribas Asset Management, put the size of flows into A-shares from passive index rebalancing at $2.1 billion by next August. Including active managers, that could be substantially more – up to $15 billion, she said in an emailed response to questions.

Daniel Morris, senior strategist at the same firm added that ‘when the rebalancing happens, money inflows to China A-shares will likely come largely from other EMs, but since it’s such a small weight, 0.7% or so, it’s not clear everyone within EM will necessarily sell other holdings to allocate to a-shares’.

Mansfield Mok, senior fund manager at EFG Asset Management told Citywire Asia that net new money to China A-shares within the EM index will more likely come from developed markets, including the US, UK and Japan, rather than re-allocation from other EMs.

‘The overall pie of the EMs will become bigger from a long-term perspective, because of the inclusion of the China A-shares,’ Mok said. ‘The liquidity and the size of the EMs, in terms of market capitalisation, will expand as well.'

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