China A-Shares: Is Your Emerging-Market Manager Ready?

As the Chinese New Year approaches, investors will welcome the year of China A-shares, soon to be included in the MSCI emerging-market (EM) benchmarks. But put careful consideration into determining which funds are actually ready to join the festivities.

Index provider MSCI plans a gradual integration for the vast onshore market, whose $8.3 trillion market capitalization is second only to that of the US. Though A-shares will initially account for just 0.7% of the MSCI Emerging Markets Index, it’s a major step toward assimilating China’s vast onshore equity universe into global capital markets. At full inclusion of 500 stocks, A-shares are likely to account for more than 20% of the benchmark, according to many sell-side estimates. Over the long term, the index revisions are expected to unleash $100 billion of investment in A-shares through EM vehicles.

Increasing Exposure to Chinese Markets

But are EM funds ready for the change? Overseas investment funds have been increasing exposure to China, according to a recent Bloomberg report. Yet even though 87% of mutual and index funds invest in Chinese equities—and some A-shares are already accessible—their holdings remain concentrated in offshore H-shares, traded in Hong Kong, and US-listed American depositary receipts (ADRs).

Nearly three-quarters of the funds don’t hold any onshore shares. China A-shares account for only US$14 billion (or 1.7%) of assets under management in EM funds (Display, left). And only 10 EM funds hold more than 10% in onshore equities (Display, right).

There are good reasons to be cautious about A-shares. Investors need to navigate structural imbalances in China’s debt-laden economy, concerns about the government’s macroeconomic stewardship and the large contingent of state-owned enterprises in the market.