Nearly half (48 per cent) of investors disagree with the MSCI’s recent decision to add 230 Chinese A-share, large-cap equities to its broad emerging market index, according to new research by the Asian Corporate Governance Association.
Overall, the report examined the state of corporate governance in China, a long-standing barrier for including the country’s companies as robustly in emerging market allocations. Investors that benchmark against the MSCI’s index for their emerging market equity allocations will now have to include these companies to avoid deviation.
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Institutional investors don’t have much to worry about, says Robert Horrocks, chief investment officer at Matthews Asia. “If you’re taking the benchmark as a framework and you want to stick closely to the benchmark, the inclusion of Asia is not really going to modify your portfolios much at all because it’s such a small amount.”
But broadly speaking, China’s companies do leave a lot to be desired when it comes to corporate governance and transparency, he says. However, due to the large number of individual companies operating in China, the amount that is above average on corporate governance is significant in comparison, he notes.
“The argument that China isn’t ready or that the companies aren’t of good enough quality may be one of those arguments that maybe holds up as an average, but when you look at the actual quantum of what’s available, it stops making sense.”
That said, Horrocks doesn’t necessarily believe the companies chosen to be part of the index are a representative example of the overall opportunities in China today, noting they were chosen largely on a quantitative rather than a qualitative basis. If institutional investors are keen to include China, it’s worth examining individual companies, rather than simply following a benchmark.
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“For anybody who is looking to increase their exposure to A-shares, particularly from the pension world, I would say the big advantage that you have is your long-term time horizon and your ability to be patient,” says Horrocks. ”Yes, the Chinese markets do have a strong retail component, they can be volatile at times, but it’s that volatility that allows you to pick up some of these businesses when the retail investor is rushing to the exit.
“I think pension plans, even if they’re closely following the benchmarks, would be well-served by at least spending a little bit of time looking at the opportunities in the A-share market, with a view that on the one hand, it is going to grow over time . . . and on the other, you will get opportunities when liquidity is tight in China, when the retail investor sentiment is weak, you will get opportunities to enter some of these businesses at very attractive price points.”
In watching emerging markets more broadly, institutional investors will want to keep a keen eye on where the emerging market consumer dollar is being spent, says Horrocks. “It’s overwhelmingly going to be in Asia. It’s orders of magnitude are greater, not just in the emerging market space, but in the rest of the world.”