Asset owners must chart a course into China A-shares
The date June 1 crystallised a question for asset owners across the world: What, exactly, is our Chinese share investment strategy?
On that day, US index provider MSCI introduced a small weighting of A-shares, or locally listed Chinese shares, into its global Emerging Markets Index.
Before this point institutional investors across the world could—if they wished—give relatively little thought to China’s local share market, despite it boasting a market capitalisation of $8.8 trillion (as of March 31). Foreign investors only held 2% of A-shares at that point, according to T. Rowe Price. MSCI’s decision will change all of that.
The index provider’s initial step into A-shares was small. It added 234 China A-shares into its China Index and Emerging Markets Index, but at just 2.5% of their market capitalisation. A-shares now respectively comprise 1.26% and 0.39% of the two indexes.
This will quickly change. MSCI has said it will double the effective market capitalisation of China A-shares to 5% after its quarterly index review in August. And, provided China keeps opening its local markets, the US index provider is likely to keep raising the A-share weighting in the Emerging Markets Index—potentially to 9% within a decade.
China’s overall share of the Emerging Markets Index, including offshore share listings, could increase from 31.74% today to over 50% in five to 10 years, predicted Andrew Mattock, China portfolio manager at Matthews Asia.
That is going to force heavy asset inflows. CSOP Asset Management predicted that international funds benchmarking against the Emerging Markets index will shovel $400 billion into A-shares over the next decade. JP Morgan Asset Management believes $230 billion of passive investment will flow into A-shares over the next five years.
Some asset owners see A-share investing as an opportunity.
“We don’t care about individual [Chinese] companies; it’s easy for [investing into] when you think about future GDP growth, and demographics and geographics,” said Yoshisuke Kiguchi, chief investment officer (CIO) of the $500 million Okayama Machinery & Metals Pension Fund. “We like to make investments into Chinese equities for the long term.”
But many global institutional investors are both underweight and ignorant of China’s internal share market. That will need to change.
Outside of Hong Kong, institutional investors tend to fall into two buckets when it comes to China: large and sophisticated investors who already invest into the market, and those who are only beginning to look at the country.
“[Outside of Hong Kong] the topic of China is not as big, especially as its portion of [A] shares [in MSCI’s Emerging Markets Index] is not that large today,” said Janet Li, wealth business leader for Asia at investment consultant Mercer.
For such neophyte investors, China’s local stock markets offers several idiosyncrasies. First there is its sheer scale.
“China is continent-sized, so to invest there you need to think of a large version of Japan from a few decades ago,” said Howard Wang, head of greater China at JP Morgan Asset Management. “You need to familiarise yourself with a very large investment canvass. Even when [US president Donald] Trump’s rhetoric on trade tariffs caused a market sell-off in China, some areas ticked up.”
Asset owners are initially advised to come up with internal strategy and governance plans relating to Chinese investing. This will be the first time many have had to consider it.
“Asset owners will definitely have to add to their governance resources [relating to China],” said Li. “China A-shares will be gradually growing in the index, so investors will have to understand more about them.”
The first step for asset owners is to decide whether to invest directly, or via fund managers.
Some are opting for the former. The chief investment officer of a UK pension fund, who declined to be identified, told AsianInvestor his organisation can already trade using Stock Connect. APG Asset Management, one of the biggest European managers of pension assets with €474 billion ($583 billion) in assets, is moving to build up its exposure to Chinese stocks, according to APG Asia chief executive Wim Hazeleger.
“We are building up our China exposure across a number of strategies,” he told AsianInvestor in February.
In addition to establishing a new A-share fund, APG runs a global emerging markets relative-value portfolio that is benchmarked to MSCI’s Emerging Markets index and a global emerging markets small- and mid-cap strategy, said Hazeleger.
Kristian Fok, the CIO of superannuation firm Cbus, told AsianInvestor in late May that he had just visited China to explore how best to invest into equities, which he intended to do via Stock Connect. Other asset owners haven’t yet finalised their strategy. For example, London-based Coal Pension Trustees Investments, which oversees the £22 billion ($29.23 billion) portfolio of the UK’s legacy coal industry pension funds, is starting to look at how to develop its investment approach to China, CIO Mark Walker told AsianInvestor.
The UK-government-established National Employees Savings Trust (Nest), with around £3 billion under management, is currently accessing China as part of its emerging-markets mandate. Nest’s allocation to emerging market equities is around 5%, deputy CIO John St Hill told AsianInvestor. While this could rise, he said the fund didn’t have a specific forecast.
Investors seeking to invest themselves will have to face several practical challenges. A key one is finding the right personnel.
“It’s important to get good technical people who understand the terminology and can interpret,” Fok said, noting that Cbus mainly relied upon its partner. “Certainly some asset owners can leverage off a specific relationship they have with asset managers.”
This story is adapted from the cover story in the June/July 2018 edition of AsianInvestor. Look out for the second part in the coming days.