A-shares – once one of the worst performing sleeves of equities in 2018 – are now increasingly sought after by institutional investors.
For example, Coal Pension Trustees, which manages the portfolios for Britain’s legacy coal industry retirement schemes, has chosen two fund houses to run its first dedicated A-share portfolios.
But whether or not investors are actively seeking out investments in A-shares, those closely tracking MSCI’s Emerging Markets Index have passively done so.
The global index provider has further increased the China A-share weighting on November 26, but even before that, the asset class has already taken up the biggest portion (33%) of the index.
While China’s capital market is still some distance from that of developed economies, the authorities have made sure that gap is being narrowed. Measures such as removing the investment quota limitations on two inbound investment schemes – the Qualified Foreign Institutional Investor (QFII) programme and the Renminbi Qualified Foreign Institutional Investor (RQFII), are in place, and more such developments are on the way.
So AsianInvestor asked four specialists whether they expect asset owners to change their allocations to A-shares in the coming year, where the biggest challenge lies and which pockets to look for and avoid.
The extracts below have been edited for brevity and clarity.
Rob Mumford, investment manager for emerging market equities
Yes. Domestic China equities (across A and B shares) became a lot more significant to global emerging market investors in 2019 as the weighting increased from 1% - which is a tracking error that can be ignored – to 3% which cannot be ignored. This immediate impact is positive flows by passive funds but as active funds become more familiar and comfortable with the attractions of domestic China exposure, allocations are likely to increase.
The attractions of domestic (including A shares) include: Higher growth, access to fast growing segments of the economy/market that cannot be accessed through offshore exposure, higher quality of growth, as well as attractive valuations – CSI 300 2020 Price to earnings ratio of 11x / earnings yield of 9% - and dividend yield of 2.8%. Compares to the MSCI World index at a price to earnings ratio of 16x / earnings yield of 6% and dividend yield of 2.5%.
The biggest challenges are the pace of global growth and the impact of geo-politics and US FX and interest rates.
Attractive opportunities include a number of sectors where there is a much broader range of companies available versus purely offshore listed choices – most notably among technology, consumer, industrials and healthcare.
Unattractive: Where there is the equivalent offshore and onshore exposure for a stock for examples in Financials, Materials, Energy - and where in certain cases the domestic shares trade at a valuation premium to the offshore equivalent, then this type of exposure would be less appealing.
Jacky Choi, chief investment officer
Zeal Asset Management
With global benchmarks increasing A-shares, we believe that more and more global investors will seek to increase allocation and remain in the A-share market to hunt for treasures within.
The biggest challenge for upsides in the A-share market remains in the growth stocks. Expectations and prices are both too high in this area, while the equity risk premiums in general are too low or even negative.
The PEG (price-to-earnings over growth ratio) for many popular growth stocks are trading at as high as 1.3 times to over 2 times, which means many investors only want to look for certainty but they either don’t realise the excessive premium they are paying for perceived visibility, or they simply don’t want to pay attention to anything which they have relatively low conviction on.
We would avoid over-priced growth stocks with crowded positions, such as selected names in consumer discretionary and technology sector. On the other hand, stocks and sectors that the market dislikes, such as cyclicals, could be our targets.
The attractiveness of the domestic A-share market is that it provides a much wider spectrum of stocks from diverse industries for overseas investors to select.
Caroline Yu Maurer, head of Greater China equities
BNP Paribas Asset Management
The cyclical policy stance of the Chinese government is still supporting GDP growth, but that goal is balanced against other goals rather than making it the overruling priority. In our view, this policy direction is structurally positive to China’s rebalancing efforts over the long term, although this could translate into weakness in Chinese stocks in the near term.
Valuations of China A-shares also remain undemanding; given that they are trading at a discount relative to those of developed equity markets. In terms of our portfolio strategy, we believe that China’s equity markets are increasingly led more by structural than cyclical factors.
In the China A-share space, we find more investable ideas across the consumer staples, discretionary, health care, insurance sectors. In the technology space, our view is more mixed as we can find a lot of quality tech companies listed either on the Hong Kong or on US stock exchanges.
Overall, the key downside risks to our expectations hinge on domestic factors (e.g. financial debt reduction, property developers’ debt in a slowing real estate market which can dampen consumer sentiment) and external headwinds (e.g. further escalation of Sino-US trade tensions, uncertainties in the US economy).
For our portfolio positioning, we have increased our A shares allocation this year up to about 30%. Depending on the market environment and investment opportunities, we should maintain our China A-share allocation at the current level for 2020.
Tan Eng-Teck, senior portfolio manager
Nikko Asset Management
We believe the inflows of foreign funds into China stocks will continue in 2020 and for years to come, as more index providers (including FTSE Russell and S&P Dow Jones Indices) start to include more China A-shares in their equity indices.
A further worsening of the US-China trade disputes wouldn’t be good for global financial markets. But it wouldn’t be all bad for China stocks. There are still stocks and investment themes in China that could benefit from the current trade war with the US, such as in the areas of semiconductors, electronic components, 5G and high-end industrial goods/machinery.
In a nutshell, we continue to be sanguine on China equities from a bottom-up, stock selection perspective. While geopolitical concerns about the US-China trade war could continue to cause volatility, we remain focused on areas with policy support, on firms with strong domestically-driven earnings and those with quality franchises—namely in technology and software, automation, high-value-added manufacturing, healthcare, insurance and select consumer sub-sectors.