As of June, mainland Chinese shares traded on the Shanghai and Shenzhen exchanges (so-called A-shares) will be included for the first time in the select indices of index provider MSCI. A-shares are generally only available for trading by mainland Chinese residents and are listed in Renminbi. Foreign institutional investors have also been able to trade since 2002, after receiving a corresponding license to do so.
This coming Monday, the MSCI will announce the A-shares that may be included in the indices in future. So far, a press release has only stated that a total of 234 Chinese shares would be added to the global and regional MSCI indices. Based on the indices of the New York index provider MSCI, Bloomberg puts the volume of investors’ money managed worldwide at nearly two trillion US dollars.
The initial weighting of the A-shares will be a two-step process; the shares will be represented in the indices with a considerably lower weighting than the current appropriate market value. Only 2.5% of the free float capitalisation will be taken into account in the first round at the start of June. The participation factor will be increased to five percent of capitalisation as of September. In view of these low participation rates, Chinese A-shares in the MSCI flagship Emerging Markets index will represent less than one percent of the index capitalisation initially. Their role will therefore remain insignificant for now. However, the index provider chose this approach deliberately, so as to prevent front running on Chinese shares ahead of the changes. Investors and funds that want to use the MSCI indices as a reference for their own yield development, will be forced to buy Chinese A-shares in the future too.
MSCI itself has stated that it will increase the participation rate of Chinese A-shares continuously in the years ahead, so that China’s true importance as the world’s second largest economy will also be reflected in the capital markets after a certain period of time. However, the speed at which this will happen also depends on how quickly China liberates the domestic capital markets and to what extent this will be sustained. In the case of the Korean equity market, its path to a 100% inclusion factor in the MSCI Emerging Markets Index took seven years (1991–1998). The road to full inclusion in the MSCI EM index took nearly eight years (1996–2004) for the Taiwanese equity market. In our view, China will undoubtedly deliver a positive surprise as regards the speed at which it will liberalise and open up the equity markets. The sheer size, the advantages of central supervisory authorities and the will to ‘belong’ to the international capital market suggest that Chinese A-shares will be counted fully at a faster pace than their Korean or Taiwanese counterparts. China learned a lot following the crash on the domestic equity market in 2015 and 2016, and paid more attention to topics such as liquid futures markets, corporate governance etc.
From an investor’s perspective, it is time to address the discrepancy between China’s economic performance, which is also expressed as a high market capitalisation of shares, on the one hand and the low index weighting on the other. With market capitalisation of nearly USD 8 trillion, the Chinese equity market has been too big for far too long to continue to be ignored by investors. We believe the Chinese equity market has the potential to make further gains on the US equity market in the long term. Structurally, high economic growth and China’s increasing transformation towards becoming a developed economy with a focus on consumption, services and technologies argue in favour of Chinese equities. As regards the traditional macroeconomic reservations against China, especially that growth is debt-financed, a distinction must be drawn between equity/microlevel. Even now, companies such as Alibaba, Tencent or Baidu (all listed on US exchanges) already command dominant positions in Asia and are also pushing increasingly to the fore in western markets. China is also expected to create more new industry and technology champions in future-oriented industries, such as robotics, FinTechs and healthcare in the coming years.