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MSCI to include China ADRs: top fund managers react

MSCI to include China ADRs: top fund managers react

Index provider MSCI has announced it will add 14 US-traded Chinese stocks to its indices, a move that will give a boost to some of China's biggest technology companies.

Among the ADR additions will be those from e-commerce website operator Alibaba and search engine Baidu.

The inclusions will come into effect on November 30.

Citywire Asia asked fund managers what this means for China's tech sector and whether this will lure investors back into the country's volatile equity markets.

Carolineyu Maurer, BNP Paribas Investment Partners

Head of Greater China Equities

We have been anticipating the MSCI rebalancing event, and view it as a very positive change for investors of Asian and Chinese equities. The index change would effectively bring down the significant weight of “old economy” sectors such as financials and telecom services, and expand the weight of the technology (internet) and consumer discretionary areas.

As Beijing pushes forward with the restructuring of its economy to shift China’s industries up the value chain, there will be significant policy support backing technology and consumer services related sectors. The new MSCI index composition will much better reflect the future growth engine of China in the coming years.

Over the summer months our team has completed a review of selected China listed ADRs and already started to build-up positions in a handful of internet names, taking advantage of the Q3 share price volatility and in anticipation of the MSCI index change.

Xiao Li, Eastspring Investments

Portfolio Manager

The 14 Chinese ADR stocks being included were widely anticipated so there weren’t any major surprises. The only major unknown prior to the announcement was how much index weight would Alibaba be factored in because of its recent IPO lock-up expiry.

MSCI China will have a significant increase in IT exposure after the change and once the inclusion is completed at the end of May 2016, IT exposure in the index would more than double from its current exposure of around 13.5%. At the same time, there will be a reduction in exposure to Chinese financials in the benchmark which would make the exposures to IT and financials more balanced.

Our investment strategy does not change as we continue to try and find stocks in China that will provide the highest upside for our investors using our bottom-up stock investing approach.

From a risk perspective, we will need to look more closely at our exposures to the IT sector given the large weight changes that will be made to the benchmark.

Raymond Ma, Fidelity Worldwide Investment

Portfolio manager, Fidelity Funds - China Consumer Fund

The inclusion of US ADRs into the MSCI China Index will significantly increase the weightings of internet-related stocks in the index.

This could give a boost to some of China’s leading internet giants as the move will trigger immediate buying among funds that passively track the index.

As these new constituent stocks are more geared towards domestic consumption and “New China”, it could also attract flows from actively-managed funds as investors are looking for exciting and sustainable growth stories in the low-growth world.

US-listed ADRs have experienced a good run since late September, suggesting that investors have been buying ahead of the inclusion in November, in anticipation of additional demand for these stocks.

Meanwhile, as the inclusion of the ADRs will come largely at the expense of Chinese banks, Chinese banks may underperform in the medium term as they are expected to see some selling.

Mansfield Mok, EFGAM

Senior fund manager – China equity

Being the world’s second largest economy, China is hugely under-represented in the world equity index.

The inclusion of 14 China ADRs marks the beginning of a significant shift for Chinese equities' presence in the global stage.

The move brings notable positives - the weighting of China in the emerging market will rise; the broadened coverage of the equity benchmarks should add buying interests and attract foreign portfolio inflow.

We have a high conviction investment approach and do not stick to the benchmark.

As the current valuation of the big ADRs appears to be relatively rich, we maintain our strategy to select undervalued growth stocks despite the increase in IT sector weighting.

With a medium term investment horizon, we consider the new “consumption theme” and the state-owned enterprise reform plays, supported by government policy, should represent a better risk adjusted return, compared to the over-owned expensive internet plays.

Matthew Vaight, M&G Investments

Portfolio manager, Global emerging markets equity

Chinese tech stocks are expensive. From a purely Chinese perspective – they are the most expensive sector in the market, by quite some distance. 

In a low growth environment, there are few areas that offer higher growth rates than Chinese tech companies and that has caught the attention of global investors.

This poses quite a challenge therefore in terms of how to ascribe valuations to companies that, in a number of instances, are factoring in very high future growth rates.

Nevertheless, that isn’t to say that the sector therefore is completely off limits to more value-oriented investors.

For instance, the shares of a Chinese search engine sold off quite meaningfully over the summer, largely due to investors’ concerns about the amount of capital the business was committing to a number of non-core businesses.

However, in our mind when you really analyse the market’s valuation of the company, the core search business is priced at a reasonable multiple given their dominant position and growth potential, though the ‘online to offline’ businesses were effectively being written off.

It is wrong to ever write off a whole market or sector from a valuation perspective; there will nearly always be opportunities to be had if you look hard enough.

The Chinese technology sector is no exception. There are undoubtedly some expensively valued companies that are pricing in very optimistic growth rates, that are ignoring fairly material corporate governance issues but there are still some opportunities to be had for active investors.

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