Goldman Sachs tells investors theyÆre underweight Asian stocks
Global institutional investors should acquire their own quotas for China's qualified foreign institutional investor (QFII) programme to take advantage of an expected rise in Chinese market cap among global indices.
Gene Reilly, Hong Kong-based head of Asian equities at Goldman Sachs, last week told an audience of Asian and North American pension funds that Beijing would look favourably on QFII requests from such institutions, as it seeks to create more long-term, anchor investors in its securities markets.
He was speaking at the annual Asia conference of the Pacific Pension Institute, held this year in Bangkok.
Reilly noted that Asia's market cap -- including Japan -- would rise from about 30% of the global total today to 40% by 2029, with China's share more than doubling, from 10% to 21%.
Despite this size, China has a negligible weighting in leading equity indices because of currency convertibility and other factors. Today it accounts for 9% of global GDP, yet comprises only 2% of the MSCI All Countries Index and isn't even included in the MSCI World Index.
Any investor tracking MSCI global equity indices is therefore massively underweight China as an economy. As a rule of thumb, GDP levels should roughly match market cap weightings, meaning that over the coming two decades, global investors will be net buyers of Asian stocks and net sellers of stocks from North America and Europe.
Most global investors have been underweight (or absent from) mainland China A-shares because these aren't considered investible, but Reilly argues that they are investible, via the QFII programme.
"Do you apply now for QFII quota or do you wait for full convertibility and A-shares being added to the MSCI World -- and at what valuation?" Reilly says, suggesting that those who wait will find the market more expensive.
Another factor holding back investors is fear over liquidity in China, but Reilly notes retail investors in China provide more than double the level of market turnover than those in the US. "A-shares are hugely liquid," Reilly said.
He highlighted a different type of constraint to investing in A-shares -- the lack of investment professionals in China and the relatively smaller teams of brokers and fund managers that global firms put in Asia versus Europe or the US.
(The presumed subtext of Reilly's argument is that global investors should therefore look to trade Asian equities via a firm with its own QFII quota and regional infrastructure, which would include Goldman Sachs.)
Reilly outlines several themes that his research colleagues are recommending to global investors. For China, this includes plays on domestic demand, urbanisation and green technology, and buying on price dips.
For Japan, the election of the Democratic Party of Japan and the rising yen both suggest pressure on exporters, construction companies, consumer finance and mass transit developers, but support for cleantech and childcare companies.
India's story is about its growing workforce and infrastructure needs (again stocks are fully valued, so buy on dips), while the Taiwan story still centres around improved cross-strait relations and cross-border M&A with mainland companies.
Reilly fielded several sceptical questions from investors in the audience, particularly over corporate governance in China. He argued that corporate governance should be judged company by company, although other speakers disagreed, saying that regulation and legal enforcement is decided by governments.