Buoyant Chinese stock market awaits MSCI decision
Index provider is expected to increase China weighting despite governance worries
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The end of a month in which Chinese shares have trounced every other market may appear the perfect backdrop for MSCI, one of a trio of index providers that have an outsized role in shaping the global flow of money.
The New York-based company is set to announce later this week that the weighting of Chinese shares in its Emerging Markets index, which is the benchmark for about $1.9tn of funds, will more than triple by August, according to people familiar with the matter.
A big jump in the weighting would underline how Beijing is opening its capital markets to foreigners despite tensions with Washington, coming less than a year after MSCI admitted Chinese A-shares, or those listed on exchanges in Shanghai and Shenzhen, to its index for the first time. It would also show how concern over the volatility of Chinese stocks and corporate governance have not been an impediment, either.
“Lest we forget, despite China being the world’s second-largest economy, it’s still emerging, and the stock market is immature versus developed markets [and] there’s massive volatility,” says Ashley Dale of Harvest Global Investments.
Analysts estimate that the plan, which is expected to push the weighting of A-shares in the index from 0.71 per cent to 2.82 per cent, as well as other initiatives to unlock China’s markets, could draw in about $100bn of foreign investment to the country’s mainland bourses this year. The CSI 300, China’s benchmark equity index, has surged 22 per cent this year after plunging by a quarter in 2018.
MSCI, whose own shares have doubled since the start of 2017 thanks to the boom in cheaper, passive investing, started consulting last September with asset managers on the increase in A-shares.
Alongside the move by MSCI, China has taken other steps in recent years to open its capital markets. In 2014, for example, the Hong Kong-Shanghai stock connect was launched to allow foreign investors to buy mainland stocks via Hong Kong.
“MSCI inclusion in 2018 marked a breakthrough year for foreign inflows, and we expect 2019 to be another record year of A-share globalisation,” says Steven Yang, a strategist at CLSA.
He estimates that stocks on the Chinese mainland will see between $83bn and $108bn of foreign inflows this year, when combined with other measures, including allowing more foreign funds to be distributed in mainland China, and the prospect that other index providers such as FTSE and S&P include A-shares. That is up from $45bn in 2018.
“Overseas investors, rather than domestic fund managers, will become the most important players,” Mr Yang adds. Foreign fund managers have sharply increased their exposure to A-shares since they were first included in the MSCI EM index in May last year.
“With the MSCI weighting set to get bigger, those managers who are underweight A-shares will need to add to their position,” says Eric Bian, a fund manager at JPMorgan Asset Management. “Until now, foreign investors have concentrated on blue-chip names, but as the index weighting gets larger, the hunting ground will become bigger.”
But even as those outside China have stepped up their buying, foreign ownership of the overall market value of A-shares stands at just 3.5 per cent, according to BNP Paribas. This compares with 20 per cent for stocks in India, about 30 per cent in Japan and Korea, and nearly 40 per cent in Taiwan.
Investor fears over China MSCI index inclusion
MSCI’s decision to beef up China’s weighting comes despite it conceding that the number of trading suspensions among China A-shares was “by far the highest in the world”. This was particularly prevalent during a plunge in Chinese shares in 2015, when more than 1,400 companies, about half of the total, suspended their shares.
In an effort to assuage concerns, last year MSCI created a rule that prevented companies whose shares had been suspended for at least 50 consecutive days from being included.
But real fears over corporate governance remain.
According to MSCI’s own ranking last year of environmental, social and governance standards, the A-shares that were included in its EM benchmark fared far worse than their counterparts in other emerging markets.
“For now there aren’t many companies that meet the standards we would expect before we commit our clients’ money,” says Nicholas Yeo, head of China equities at Aberdeen Standard Investments. “We place heavy emphasis on fundamentals such as earnings and valuations and take account of good governance.”
Mr Yeo hopes that, ultimately, the opening of China’s capital markets through decisions like MSCI’s will “expose the management of companies to global standards of accountability and best practice.”
In the meantime, many investors are likely to have to increase their exposure to A-shares – and hope that last year’s volatility becomes a distant memory.