Asset owners in the Middle East and Southeast Asia have been tipped to drive a big influx of money into Chinese stocks after their partial inclusion in MSCI’s emerging market indices next month, as the index provider last night announced the first A-share constituents of its EM benchmarks (see box below).

Institutional investors in Southeast Asia and the Middle East are likely to be the first to raise their A-share allocations after the inclusion, said Melody He, head of ETF and index solutions at Hong Kong-based CSOP Asset Management, at a press conference yesterday (May 14).

Many clients in Southeast Asia and the Middle East have been asking for information on A-shares, she noted, and many large asset owners in Southeast Asia are issuing A-share mandates.

Meanwhile, institutional investors in Hong Kong, Singapore, South Korea and Taiwan have been increasing their A-share allocation through the Hong Kong-China Stock Connect trading links or ETFs since the start of this year, added He. Most of these investors are already overweight China, so MSCI’s benchmark inclusion will have little impact on them, she added.

On the other hand, US pension funds are among those long-term investors that are less prepared for the inclusion, as their weighting is small and the US market has been resilient, she said.

It may be that European retirement funds are closer to being ready, if one British corporate pension scheme is anything to go by. A senior portfolio manager told AsianInvestor in late January that the institution was set to start doing test trades through Stock Connect “any day now”.

In the next decade, $400 billion in total is expected to flow into the A-share market as a result of the inclusion, estimates CSOP.

In the next five years, A-shares could account for 9% of the MSCI EM index and 1% of the All Country World index, attracting about $230 billion of passive investment flows, according to JP Morgan.

KEY CHANGES UNDER THE MAY INDEX REVIEW

Early this morning Hong Kong time, index provider MSCI announced the constituents in the first step of the partial inclusion of A-shares, as part of its quarterly index review.

  • It will add 234 China A-shares at 2.5% of their foreign inclusion factor (FIF)-adjusted market capitalisation, representing aggregate weights of 1.26% and 0.39%, respectively, in the MSCI China Index and the MSCI Emerging Markets Index.
  • The second step of the inclusion will coincide with the August 2018 quarterly index review, when the representation of the FIF-adjusted market capitalisation of China A-shares will rise to 5%.
  • The three largest additions to the MSCI Emerging Markets Index measured by full company market capitalisation will be ICBC, China Construction Bank and Petrochina.


INFLUENTIAL LOCAL PLAYERS

Meanwhile, certain large domestic government organisations have emerged as big A-share buyers in the past few years. They have been dubbed ‘the national team’ by Chinese investors and include institutions like Central Huijin and China Securities Finance Corporation (CSFC), Swiss bank UBS said in a report yesterday (May 14).

Unlike other investors, the national team's goal is to provide stability to the market, and there are signs that it traded against market trends with the aim of reducing market volatility, UBS said. Indeed, the national team has increased its stock holdings by an estimated Rmb1 trillion ($157.8 billion) since the big Chinese stock sell-off in mid-2015, it said.

Hence, while MSCI’s A-share inclusion is expected to make the Chinese stock market more institutional and better reflect its fundamental value, it could be argued that these domestic institutional investors are in fact making it deviate from its intrinsic value.

Meanwhile, it is expected that the ‘foreign inclusion factor’ – the proportion of the MSCI EM index that mainland equities will initially account for – will be raised from 5% (see box).

“I hope MSCI will provide more visibility or guidance [on the FIF],” Kinger Lau, chief China strategist at Goldman Sachs, told AsianInvestor. The 5% inclusion factor should be raised now that the daily trading quota of the Stock Connect has increased, he said.

MUCH MORE TO COME

After all, MSCI’s symbolic inclusion of China A-shares at 0.7% of its EM index and 0.1% of its World index is a “mere drop in the ocean” compared to the size of the China domestic market, said Howard Wang, head of Greater China equities at JP Morgan Asset Management, yesterday.

Initially $6.6 billion may flow into A-shares from passive investment strategies, but flows from active funds could pour as much as $40 billion into Chinese securities, creating a powerful tailwind, Wang said.

Certainly, China is still heavily under-represented in global allocations. Since MSCI’s announcement last year of the upcoming A-share inclusion, foreign investor participation in A-shares has increased by around 30%, noted US fund house T. Rowe Price, citing data from research firm CEIC. 

Yet China’s domestic market is still dominated by local retail investors, with foreign participation in A-shares still very modest at about 2% as of March 2018, added T. Rowe in a commentary following the review announcement early this morning. That compares to close to 40% foreign participation in other North Asian markets such as Taiwan and Korea, it added.