MSCI has announced that China A-shares will be included in its emerging-market (EM) index next year, as we anticipated. Now, global equity investors need to consider how to access the vast universe of stocks traded onshore in China.
The decision on Tuesday by index provider MSCI was a watershed for equity investors around the world. China A-shares are the world’s second-largest stock market with a market capitalization of US$7.5 trillion. But their exclusion from key EM benchmarks meant that most investors simply had no way of investing and were restricted to the smaller pool of Chinese H-shares traded in Hong Kong or elsewhere.
Not anymore. By adding a small group of A-shares to the MSCI Emerging Markets Index, the door has officially been opened. The inclusion process demonstrates how MSCI has refined its approach to waking China’s giant equity market by adding only 222 stocks that are sourced under the Stock Connect regime, or over 40% of the total onshore market cap. That’s a relatively narrow universe of investible stocks, chosen from over 3,000 stocks traded onshore in China. Yet it’s a small but important first step towards improving the representation of the largest developing-world economy in the MSCI Emerging Markets Index.
What should investors do about A-share inclusion? Some may initially ignore the event, while others may consider adding a stand-alone A-share strategy. However, as China starts to dominate the EM index we believe investors should start rethinking the way they look at the broader EM equity universe.
DON’T DISMISS A GROWING OPPORTUNITY
Investors who choose to ignore A-shares may be overlooking a longer-term opportunity. While it’s true that the shares chosen for initial inclusion are only a very small part of the larger EM Index, we expect the percentage of A-shares included in the index to significantly grow over time. So by ignoring A-shares today, you would be missing compelling investment opportunities and unique China themes. Examples include leading Chinese consumer brands, world class industrial leaders and innovators that are poised to benefit from changing environmental policies.
The onshore China A-share market is very large and very liquid, but still maturing. Retail investors, who tend to follow popular trends instead of long-term earnings patterns, make up about 80% of daily turnover today. These conditions are ideal for active investors who can identify inefficiencies and long-term fundamental opportunities to generate attractive returns.