China’s stock market took a huge step forward this week as U.S. index provider, MSCI, announced it would add A shares to its Emerging Market Index. The presence of Chinese stocks in the key index will bring China’s traditionally closed market to investors around the world. What does this move mean for the index? And could it add unwanted risks for institutional investors accessing emerging markets through the index? To answer these questions, we turned to Yu Zhang, portfolio manager within the China team at Matthews Asia.
Why is this happening now?
Over the past few years, China has been making significant efforts to further open up the capital markets and we’ve witnessed the evolution of China’s A share market, not only in the number of listed companies, but also the overall quality, regulatory and corporate governance environment have been improving as well. In our opinion, China’s A share market is simply too big to be ignored by global investors. While the inclusion provides additional positive sentiment towards the market, corporate profitability will remain a more important driver of the market than MSCI’s announcement.
What impact will this have on China’s A Shares market?
The inclusion of China’s A shares officially puts China on the map for global investors and is regarded as a milestone for China’s equity markets with the rest of the global equity markets. Over the short term, the inclusion of A shares at 0.73% of the MSCI EM index, which is estimated to be an additional inflow of US$10 – $11 billion against a market with daily trading volume of US$50-$60 billion, will not be impactful.
Does this make the MSCI index more risky? Volatile?
There are, of course, challenges and improvements to be made so careful stock picking is particularly important. China’s A share market is still relatively young and the overall market is currently dominated by retail investors. Trading could be volatile and government intervention can be heavy-handed. However, we are encouraged by the strong potential and opportunities in the markets and truly believe that long term investors can benefit from having exposure into the market.
How could this impact the overall Chinese economy?
There are currently over 3,000 listed stocks in the A share market—some of which have unique business models that can’t be accessed by tapping overseas listed companies which can help add diversification benefits to global investors. By including A shares to MSCI’s global indices, it will introduce additional investors, i.e., global institutional investors who are fundamentally long-term in style, which will help China’s markets to be more healthy.
Will this move make the MSCI index more compelling for investors?
In the past, the exclusion of A-shares deprived index-based foreign investors the unique opportunity to directly participate in companies that are benefiting from one of the most dynamic economies in the world. Over the past years, we have witnessed the evolution of China’s A share market, not only that the number of listed companies have been growing substantially, but also the overall quality, regulatory and corporate governance environment have been improving as well.