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‘Watershed’ moment for China: managers react to MSCI switch

‘Watershed’ moment for China: managers react to MSCI switch

MSCI will include China A-shares in its benchmark emerging markets index, which is tracked by more than $1.5 trillion of assets under management, the index provider has announced.

As a first step in its inclusion, MSCI will add 222 China A Large Cap stocks, which will represent 0.73% of the index. As the market develops, it will increase A-shares’ weighting.

Many emerging market investors will have to rebalance their portfolios as their exposure to China through the index grows, but changes look set to be gradual. 

But, how are leading investors responding to the change in EM emphasis and is the addition of A-shares outwardly positive or cause for concern?

‘Softly, softly’ approach

Citywire + rated John Lin, who covers China equities at AB, said the addition of China A-shares is a ‘watershed’ moment and the entire A-share market will be added eventually.

‘The way in which the inclusion process happened demonstrates MSCI is taking a “softly, softly” approach to waking the giant, adding only A-shares sourced under the Stock Connect regime, therefore narrowing the initial universe of investible stocks to 222. 

‘The full China A-share market is very large, very liquid, but still maturing, with retail investors making up about 80% of the daily turnover. These conditions are ideal for active investors that are able to identify inefficiencies - such as mispricings due to emotional or herd trading - and long-term fundamental opportunities to generate attractive returns.

‘It’s important to reiterate that this is just the first step, and MSCI is unmistakably on the path to include the entire A-share market into its indices. When this happens, the overall weight of China could approach half of the MSCI EM benchmark. 

‘Investors should start thinking today about the future impact on their global and EM equity allocations, including the possibility that we will see the EM index being split into All China and EM Ex-China.’

Corporate governance still lacking

Citywire AAA-rated Gary Greenberg, head of emerging markets at Hermes IM, said, while the inclusion is positive, more work needs to be done by domestic Chinese companies to show they are worthy of investment.

‘In our experience, many Chinese A-share managements have yet to fully grasp the duties imposed by a listing, not to mention inclusion in a global index. We continue to encounter managements of large A-share companies who have yet to appoint an investor relations officer and who see no reason for senior management to meet shareholders.

‘Governance is often a challenge, as management may owe primary allegiance to municipal, provincial or national administrations. Capital discipline, avoiding low-return projects, can run into conflict with the requirements of a related city or province for new infrastructure. 

‘The ability to communicate with foreign investors, even in companies with worldwide operations, tends to be less than world class. For businesses with top line revenues that can top $15 billion, this should have been fixed by now.’

Slow and steady

Bill Maldonado, CIO for Asia Pacific, HSBC GAM, believes MSCI is right to cautiously introduce the stocks and it will allow international investors to tentatively invest in China.

‘While the inclusion is unlikely to be the catalyst that sparks a re-rating of the market in the short term, it is conducive to capital inflows to the onshore equity market in the long run. 

‘As the global economy shifts from West to East and China continues to progress its RMB internationalisation agenda, more international investors will recognise the immense investment opportunities China offers and gradually start getting and increasing exposure to the country in their diversified portfolios.’

First step towards own asset class

Investec’s Greg Kuhnert, who runs several funds including the Investec All China Equity fund, said the slow introduction could pave the way for a much greater role for Chinese stocks in the future.

‘At long last, MSCI have included the second largest equity market in the world in their indices, thanks to improved accessibility from the Hong Kong and the Shanghai and Shenzhen Connect programs.

‘Whilst the inclusion factor is initially small with 222 China A large cap stocks included and estimated inflows of only $1.5 billion initially, the stage is set for a pathway to greater inclusion further down the road.

‘Our view is that in the long term China as a country will play an outsized role in regional and emerging portfolios and may in itself become a unique asset class for asset allocators across the world.’

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