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Chinese A shares join MSCI club and change the world investment landscape

A huge market offers an abundance of investing opportunities for foreigners
posted onJune 2, 2018

After years of anticipation, a total of more than 230 Chinese large-capitalization A shares debuted on index provider MSCI's indices, including the MSCI Emerging Markets Index, on Friday, opening up the world’s second-largest equity market to foreign investors. 

“China's equity market now officially enters the global space," the J.P. Morgan analysts said in a note. 

The move has triggered heightened interest in A shares- stocks that historically were available only to Chinese investors- and has broad support from international institutional investors given the policy changes Chinese regulators  have introduced over the past few years to attract more foreign capital in their markets.

Analysts believe a key driver behind MSCI's decision to include mainland-listed companies in its indexes was the growing international demand for investing in the world's second-largest economy and the introduction of Stock Connect programmes.

The Stock Connect effect 
Stock Connect, allows for two-way trading between China’s mainland markets in Shanghai and Shenzhen and the Hong Kong Stock Exchange, allowing more foreign investors to gain exposure to Chinese A-shares. It was first launched in November 2014 between the Shanghai and Hong Kong exchanges and was extended in late 2016 to encompass the Shenzhen market. A survey by Copley Fund Research showed that cross-border flows have ramped up over the last 12 months with 180 global emerging market funds having funneled around $1.2 billion into A shares. 

A gradual process leading to “bigger jumps” 
Full inclusion of the A shares- stocks of Chinese companies incorporated on the mainland, quoted in renminbi, and listed in Shanghai and Shenzhen- into MSCI indices does not come immediately. The partial 5% inclusion of the A shares — to MSCI's flagship Emerging Markets Index takes place in two phases, 2.5% effective June 1, and 2.5% on August 31.

The New-York based MSCI said it will make "bigger jumps" in expanding the presence of China's A shares in its benchmark indices after accessing feedback from overseas asset managers.

MSCI Inc CEO Henry Fernandez during an interview with Bloomberg Television
(MSCI Inc CEO Henry Fernandez during an interview with Bloomberg Television Photo Credit: Bloomberg)

"We don't want to do a large number of small inclusions, but a small number of large inclusions. We want to do bigger jumps," China Daily quoted Henry Fernandez, chief executive officer of MSCI as saying at a news conference in Beijing. "If we were to include both large and mid-cap stocks, half of the companies covered by the MSCI EM index would come from China," Fernandes added. 

According to a 15 May report by Morgan Stanley,  Friday's inclusion should result in just a $1.7 billion passive fund flow while the the second phase of inclusion should result in another $1.7 billion. MSCI estimates this first phase could  result in $22 billion in inflows while Citigroup expects $48 billion of annual inflow. If the index provider eventually greenlights full inclusion for A shares, $300 billion could flow into those stocks, Reuters estimated.

(Hangzhou Hikvision Digital Technology Co., surveillance cameras manufacturer)

Notable inclusions on the list
 Among the names included on the list were a mix of pharma, food & beverage firms financials, tech companies and consumer goods. Below are some notable inclusions.

  • Jiangsu Hengrui Medicine Co., China's biggest drugmaker by market value.
  • Kweichow Moutai Co., China’s biggest liquor maker in terms of sales and a maker of the traditional Chinese spirit known as baijiu. 
  • Hangzhou Hikvision Digital Technology Co., the world's largest supplier of video-surveillance cameras, with more than 20% of the global market, and one of the most valuable tech companies on China's domestic exchanges. 
  • Midea Group Co., a major Chinese appliance producer, which acquired German robotic maker Kuka in 2017.
  • LONGi Green Energy Technology Co., the world’s second-largest maker of solar wafers
  • Industrial and Commercial Bank of China, the nation's largest lender
  • BYD, an electric vehicle manufacturer 
  • Zhejiang Huayou Cobalt Co. and Jiangxi Ganfeng Lithium Co., battery-component makers 
Moutai Co
(Kweichow Moutai Co., liquor maker)

Transforming EM investing 
The move is an extremely significant step in the opening-up process of China's domestic stock market, one of the largest in the world by volume and market capitalization, and would increase the visibility of Chinese equities to outside investors. 

"This is a really important event that could change the face of EM investing," Sebastien Lieblich, global head of index management research for MSCI, told the media Thursday morning New York time. 

“Investors can’t ignore China’s domestic market any more,” Jinming Hu, chief executive officer of GF International Asset Management, the first wholly owned Chinese fund to launch in Europe told the Financial Times “Overseas investors now have no choice but to accept that mainland China’s equity markets are part of the world.” 

“The MSCI’s inclusion of China is a milestone step, demonstrating that global investors now officially welcome China to the global stage, after a gradual opening up of this market through QFII, RQFII and Connect programs,” Jasmine Kang, portfolio manager, Comgest China Growth Fund told The Trade.

(BYD, an electric vehicle manufacturer)

Warnings about the risks  
Meanwhile there are those who believe more exposure to China—and especially A shares— equals more risk as poor corporate governance, a chronic problem among many Chinese companies, trading suspensions and other issues are reasons for concern.

During China's stock market crash in July 2015, more than 1,400 of the 2,800 companies listed on the Shanghai and Shenzhen exchanges suspended trading.

"Beijing has shown a very strong inclination to make sure that they control the financial markets," Christopher Balding, associate professor of business and economics at the HSBC Business School in Shenzhen, told the Nikkei Asian Review. "As long as that remains the dominate paradigm, it's difficult to see any of these rules changing." 

"Liquidity risk and market intervention, unfortunately, would be part and parcel of investing in A shares at this stage," Pruksa Iamthongthong, senior investment manager at Aberdeen Asset Management Asia, told CNBC's "Street Signs." 

“Investors need to be very careful,”Brandon Emmerich, principal at Granite Peak Advisory told the FT. “The debts of some companies, such as the big property developer Poly Real Estate Group which has debt to ebitda of 18.6 times, are extreme.”

Looking beyond the indices and headlines, emerging markets including countries such as China, India and Brazil tend to have a big impact on global economic growth in the coming years and decades. China is the largest emerging markets country and has the world’s second-largest GDP. It accounts for 20% of global trade and 7% of global consumption. Shanghai’s stock exchange,opened in 1890, has a market cap of 32.07 trillion yuan ($5 trillion) and Shenzhen’s exchange has a market cap of 22.4 trillion yuan ($3.49 trillion). For sure you cannot ignore them.

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