Briefly…on Taking China’s Stock Market Global

May 24, 2018//-On June 1, index provider MSCI will include mainland Chinese stocks, known as A-shares, into its benchmarks which are closely watched by international investors and used to guide the allocation of trillions of dollars in assets that are currently tracking them. Kinger Lau, Chief China Strategist of Goldman Sachs Research, and Christina Ma, Head of Greater China Equities of Goldman Sachs Securities, discuss the implications for China and investors.

How significant is this move — which has been years in the making — for investors?

Kinger Lau: While China’s initial A-share weighting in the MSCI Emerging Markets Index is small — representing 0.8% of the EM index after September 1 — there will be consequential flow implications over the long run since global funds tracking the MSCI indices will have to buy Chinese stocks to comply with their mandates. Importantly, we see this event as a paradigm shift because it transforms China’s A-share market from a “nice-to-have” to a “have-to-have” market, and redefines how global equity investors think about their opportunity set and capital allocation over time.

Investors can already get exposure to China through offshore-listed Chinese stocks — H shares that are listed on the Hong Kong Stock Exchange or other foreign exchange or through ADRs on US exchanges. What’s different about the A-share market?

KL: Investors get broader access to companies that exemplify China’s transformation to a consumer-led economy. There are unique sectors in China’s domestic market, for example, which offer exposure to healthcare, new economy and service businesses. The market has delivered strong earnings-per-share growth over the past decade. And from a valuation perspective, China A-shares look attractively priced relative to other global equities.

The MSCI inclusion appears to be just one step toward China’s broader attempts to open up its financial markets. What are the others?

Christina Ma: The MSCI event is part of the progressive opening of China’s markets and, after its announcement last year, kicked off a series of moves aimed at further institutionalizing China’s stock markets.

Over the past year, for example, China’s securities regulator released guidelines allowing for greater foreign ownership in Chinese joint ventures; introduced rules to woo overseas-listed China companies back home through China Depositary Receipts; and gave global investors greater access to the domestic stock markets through trading links between the Shanghai/Shenzhen and Hong Kong stock exchanges.

Ultimately, Chinese regulators want to strengthen and improve the country’s equity markets. The benefit for investors is that they should ultimately be able to invest in stronger, blue-chip Chinese companies.

What are some of the long-term ramifications?

KL: The China A-share market is retail driven, with retail and institutional investors representing about 80% and 20%, respectively, of total turnover. That ratio is reversed in the more-developed Hong Kong market where retail and institutional investors represent 20% and 80%, respectively, of turnover.

Markets with high levels of retail participation are typical of developing markets

Markets with high levels of retail participation are typical of developing markets until the culture of investing with professional money managers becomes more pervasive. Additionally, the fact that equities are…
until the culture of investing with professional money managers becomes more pervasive. Additionally, the fact that equities are under-owned by Chinese households compared with other economies, suggest that there is a significant potential for asset allocation flows to equities.

CM: The increased participation by international institutional investors is crucial to the long-term development of China’s financial markets. Long-only investors make their allocation decisions based on weighted benchmarks and rebalance assets on a regular basis, effectively adding stability to the underlying market.

They will help foster an investment culture focused on fundamentals, which would help balance the more speculative nature of retail investors who dominate the domestic market. From our perspective, we’re seeing foreign clients doing far more work in China and thinking about their onshore strategies here. The volume of meetings and conversations that we’re having is probably more than five times what it was a year ago.

Goldmans Sachs 

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