June 2018

OPINION: Asia ex-China?

Fiona_RintoulThe inclusion of China A-shares – large-cap Chinese stocks, traded domestically – in the MSCI Emerging Markets index and MSCI AC World index on May 31 may not have been met with a clamour by investors. But it was significant.

Initially, the move won’t make that much difference to China’s overall weight in the index because of the low inclusion weight. Inclusion is at 5% weight and is to happen over two phases. Half was included on May 31 with the balance to be added in August. This will boost China’s proportion of the MSCI Emerging Markets index by only 0.8% to 31.3%, while China A-shares representation in the MSCI AC World index will be just 0.1%.

However, the inclusion of A-shares in these indices is part of a process. Chin Ping China, head of research for Asia-Pacific at MSCI, says “emerging markets may never be the same”.

The journey to this point has been more than 15 years long, and somewhat torturous. It began in 2002 with the launch of the qualified institutional investor scheme (QFII), which allowed foreign institutional investors that met certain criteria limited access to China’s domestic capital markets for the first time.

What is more, MSCI’s approach has been ultra-cautious. Eng-Teck Tan, senior portfolio manager at Nikko Asset Management, notes that the 5% weight is the lowest MSCI has ever given to a country being introduced to its indices for the first time.

This may help to explain the muted reaction. Chin Ping China also ascribes the absence of brouhaha to investors’ unfamiliarity with the Chinese domestic market when MSCI first proposed including China A-shares in its emerging markets index.

“Five years ago, when MSCI floated the idea of adding China A-shares to its mainstream indices, global investors were unenthusiastic,” he says. “Global investors were unfamiliar with this market because they were unable to access it.”

Now they can. In 2016, the extension of the Stock Connect program to Shenzhen-traded shares provided a breakthrough. The inclusion of 233 A-shares in the MSCI Emerging Markets index is a breakthrough of another sort: it represents a maturing and normalising of China’s place in the investment universe.

Now it’s all about the future. The A-shares market is one of the biggest in the world, with more than 3,000 stocks traded. If the Chinese market continues to liberalise enough, it might warrant full inclusion. If that were to happen, China equities could comprise 42% of the MSCI Emerging Markets index, with A-shares alone accounting for about 16% of index weight.

“Our view is that this is more a symbolic indication of a trend which will only strengthen over the coming years,” says Pablo Urreta, head of research at Sussex partners. Eng-Teck Tan thinks that the 5% inclusion factor “can and will be raised”.

The significance of the MSCI move goes beyond investment. It was probably coming anyway, but with many democracies struggling to control populism or in the control of populist leaders, China – despite remaining a communist dictatorship – is poised to become the economic giant of the 21st century. As China Post Global managing director Danny Dolan puts it: “China is a long-term megatrend... investors have noticed [its] ever-growing importance to the global economy and are increasingly keen to benefit from China’s ongoing strong growth.”

Investors are used to managing portfolios of Asia ex-Japan. Eng-Teck Tan believes it isn’t far-fetched to imagine a day when Asia ex-China portfolios will be the norm.

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