The inclusion last month for the first time of China-A shares in MSCI’s widely tracked emerging markets index, with the weighting set to be incrementally increased in September and subsequently, had been expected to move millions of dollars into mainland Chinese markets.
But with global trade tensions increasing, emerging market assets for now falling out of favour as US interest rates rise and the dollar strengthens, and Chinese economic growth slowing, that hasn't given Chinese stocks the desired leg-up yet. Shanghai's SSE Composite Index, for example, is down on where it was on June 1, when MSCI inclusion first kicked in, and 12% lower year-to-date.
Why that should be when MSCI’s suite of emerging market indices is tracked by funds with assets under management in excess of $1.9 trillion, highlights the strength of the broader current downturn in sentiment towards emerging market assets.
It also shows why, for some asset owners in the region, the notable and symbolic MSCI milestone alone isn't enough to justify an increase in mainland Chinese stock allocations.
“While there has been a lot of talk about China and MSCI inclusion, we believe that as is the case with any other emerging market economy, apart from the fundamentals, companies need to improve their governance and reporting standards [before we can invest more],” Rohit Nambiar, chief executive officer of Axa Affin Life Insurance told AsianInvestor last week.
“Once the investing community is comfortable with these improvements, you will see more investments,” he said.
The Kuala Lumpur-based insurance firm holds positions in Chinese (including Hong Kong) stocks via funds but Nambiar didn’t provide any further details of these holdings.
Corporate governance issues within Chinese companies have been long highlighted by several experts and industry bodies.
The latest misgivings, published in a report on July 24, came from the Asian Corporate Governance Association: it also highlighted ongoing corporate governance concerns in China, noting that the widespread perception remains that many domestic companies continue to treat corporate governance as a compliance exercise and that in many instances the interests of controlling shareholders, especially in state-owned enterprises, are not aligned with minority shareholders.
The report notes that investors, however, remain optimistic that environmental, social and governance principles will assume greater prominence in time and that China’s investment potential remains strong over the next five to 10 years.
Credit Suisse’s Asia Pacific head of asset management, Michael Levin, has also said that $1 trillion could flow into China’s markets over the next decade from global institutional investors.
PASSIVE, PASSIVE INVESTMENTS
On June 1, the MSCI added 234 Chinese stocks to its indices, including ICBC and China Construction Bank. Stocks will be added in two phases in June and
August September? and will make up less than 1% of the MSCI Emerging Markets index. Full inclusion would see A-shares account for about 18% of the index, Reuters estimated in May.
“It remains to be seen how much further China will liberalise its markets and thus, warrant further inclusion of its companies into the indices," Nambiar said.
In addition, Nambiar believes the MSCI inclusion of China A-shares is unlikely to trigger significant rebalancing given the relatively small adjustment in the index in the initial stage.
The most immediate impact comes from passive investments, which must replicate the indices they track. Experts have previously told AsianInvestor that about $6.6 billion could initially flow into Chinese markets as a result of investments tied to exchange-traded funds and other passive products.
However, as Nambiar noted, the ETF market in this part of the world is not as developed or as sizeable as in developed markets.
As of the end of May, the Asia-Pacific (ex-Japan) ETF/ETP industry had amassed assets of $184 billion, which is a tiny fraction of the $5 trillion that the industry has gathered globally, according to data from London-based passives tracking consultancy ETFGI.
“In this part of the world, investing is still driven by active managers. In addition, most indices here are heavily tilted towards financials so following an index does not necessarily provide the diversification that investors need,” Nambiar said.
In the immediate future, the threat of growing trade conflicts between the US and China is also likely to keep investors cautious about market prospects for China as they keep a watchful eye on unfolding developments.
After Washington imposed 25% tariffs on $34 billion of Chinese goods on July 6, Washington has now proposed introducing 10% tariffs on a further $200 billion of imports. Beijing is expected to respond with more measures of its own and has filed a further complaint with the World Trade Organization against the US actions.
Nambiar added that as a group, Axa remains very bullish on China, noting how Axa is the largest foreign insurer in the country (through its tie-up with ICBC).
For more insights on investing in China, AsianInvestor is hosting its 5th China Global Investment Forum in Beijing on September 13. For more details, visit the website or contact us on +852 2122 5262.