MSCI’s decision in June to include Chinese domestic A-shares in its biggest international and emerging market indices, albeit in modest scale, was a symbolic landmark. But attention has quickly turned to the next step: increasing the weighting of Chinese shares to represent the true size of that market.
Chin Ping Chia,
The inclusion of A-shares, which will take place in two instalments in May and August 2018, will be in a very limited form – just 222 large-cap stocks with a 5% weighting relative to their actual size.
Consequently they will represent just 0.73% of the MSCI EM Index, compared with the 27% of the index already accounted for by China-linked stocks listed in Hong Kong and New York.
Full inclusion of A-shares at their actual market weight would account for about 20% of the emerging market index.
Euromoney asked the MSCI research team of Sebastian Lieblich and Chin Ping Chia about the next steps: towards greater weighting and towards the inclusion of mid-cap stocks rather than just large-caps.
“Looking at mid-caps and possibly going beyond 5% – these are not mutually exclusive. Potentially both could happen,” they say. “The things we would be looking for would be continuing to monitor the robustness of Connect, checking with investors to see how that is going.”
Connect is a reference to Stock Connect, a method through which investors in Hong Kong can access mainland securities. MSCI has said that Stock Connect was a large part of the reason MSCI opted to include Chinese stocks in its indices this year, having rejected them on three previous reviews, because it brings greater capital mobility, albeit still with a daily limit on transactions. This limit will be a key element monitored by MSCI.
“Another thing we will be looking at would be suspensions,” the team says. “One issue that was flagged in last year’s consultation, when we did not include China, was the fact that there were a high number of suspensions. They have come down, and that’s good, but nevertheless China is still a market where you have a very high number of suspensions. So there is room for improvement, and our stakeholders are well aware of that.”
Indeed, even if there has been an improvement, it is from a low base. “The number of trading suspensions in China’s A-share market remains by far the highest in the world,” says Hyde Chen at UBS Wealth Management, who says there are 100 A-shares suspended now, worth more than 5% of MSCI’s China A index.
MSCI appears to expect the necessary improvements to be made. “There’s been a lot of liberalization that has taken place, and from what we can see, it looks like there will be interest to continue that,” the team says.
“We look at this as a 15-year journey. Fifteen years ago you saw the introduction of QFII [qualified foreign institutional investor scheme]. The next big jump was RQFII [renminbi qualified foreign institutional investor]. In recent years, we’ve seen an acceleration of innovations and access opening up.”
There is a widespread hope that index inclusion will help to accelerate the growth of institutional practices in a retail-dominated market. Alvin Lee, head of southeast Asia client coverage for MSCI, says he is already seeing it.
“There has been a lot of discussion about how Chinese markets are driven heavily by retail, but we would observe that a lot of Chinese fund managers have gained experience trading in London and New York and come back to China employing more institutional techniques,” says Lee.
“It has started to change. We believe that is due to the growing institutionalization of the market, and now that we’ve included Chinese A-shares in some of our broader regional and global indices, you will draw more institutional money into the market. That, over time, will alter behaviour.”
The right way
A different question is whether or not passive investment in an all-encompassing index is the right way to invest in China at all.
“The index will reflect the previous winners,” says Mark Tinker, head of Framlington Equities Asia, part of Axa Investment Managers. “There is structural change going on, and you want to get exposure to the new guys. Why put 10 times as much in the big old SOEs [state-owned enterprises] as I would in the new companies?”
He says: “ETFs can only take you so far.”
Lee notes that: “MSCI currently has more business with active managers than passive,” and says there is a middle ground between passive and active investment styles: smart beta, which makes use of index-based products, but not exclusively.