In 2014, the Chinese authorities began to open the country’s local equity markets to overseas investors through the launch of its stock connect programmes, which effectively link China’s two stock exchanges to Hong Kong for trading purposes. Up to this point, the market was, to all intents and purposes, only open to local residents and those who had been granted Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) status.
This did not mean that overseas investors were completely precluded from investing in Chinese companies but options were effectively limited to ADRs, H Shares and Red Chips (see definitions below) which were not collectively representative of the broader Chinese market and failed to provide comprehensive access to all the exciting opportunities available.
ADRs:An American Depositary Receipt is a negotiable certificate issued by a US bank representing a specified number of shares in a foreign stock. The certificates are denominated in US dollars and traded on the New York Stock Exchange and NASDAQ. As of 01.03.2018, ADRs in 353 Chinese companies were listed.
A shares: Equities of companies incorporated and listed in China, denominated in local currency and only accessible to non-qualified foreign investors through the stock connect programmes.
B shares: Equities of companies incorporated and listed in China, denominated in both US dollars (shares traded on Shanghai exchange) and HK dollars (traded in Shenzhen). Accessible to foreign investors directly.
H shares: Equities of companies incorporated in China, but listed in Hong Kong and denominated in HK dollars. Accessible to foreign investors directly.
Red chips: Equities of companies incorporated outside of China but substantially owned by China state entities and deriving the majority of their revenues from China. The shares are denominated in HK dollars, traded in Hong Kong and accessible to foreign investors directly.
For context, the China A-share universe exceeds that of Continental Europe, while its market cap is greater than that of the MSCI Emerging Markets index in aggregate. Prior to 2017, the coverage of China shares within the benchmark Morgan Stanley Capital International (MSCI) indices was restricted to a select number of Chinese stocks listed in Hong Kong and Chinese ADRs in the US, but that finally changed, when 222 A-shares (with capped exposure) were included for the first time. Now the extent of A-share coverage is set to accelerate rapidly with the recent announcement from MSCI that its indices are set to quadruple their existing A-share exposure.
We asked GAM Investments’ expert in Chinese equities, Jian Shi Cortesi, to give us her views on this striking development and the prevailing trading environment.
MSCI announced it will raise the inclusion factor (IF) for A shares from 5% at present to 20% by the end of November. The transition will be progressive with 5% increases scheduled for May, August and November. In addition, to increasing the weighting in the existing large-cap A shares, MSCI will be adding 168 names in China-A mid caps. These changes will bring the A-share weighting in the MSCI China Index to approximately 10.4% from 2.3% currently. And, at the broader index level, China-A will represent 4% of MSCI Asia ex-Japan and 3.3% of MSCI Emerging Markets.
According to broker estimates, these increases could prompt potential net purchases of around USD 70 billion as many benchmark-sensitive investments incorporate the change. This will clearly be positive for domestic investor sentiment in the short term, which has already improved so far this year following a difficult 2018. The increase of A shares in the MSCI indices will also attract significant attention from foreign investors, many of whom would be ill-advised to ignore A shares as part of their investment universe going forward. Foreign investors are likely to focus A-share purchases on quality blue chips trading at reasonable prices in sectors such as consumer, healthcare and technology.
China equities endured a torrid 2018, with the MSCI China index suffering a double-digit decline in the fourth calendar quarter alone, primarily due to investor concerns over escalating Sino-US trade tensions. However, sentiment has improved rapidly from the turn of the year and a positive start has extended into February – a month in which the MSCI China Index returned 3.5%1. So far this year, we have seen constructive progress in trade negotiations and continuous appreciation of the local currency. Meanwhile, improvements in both export and import activity have helped counterbalance the concerns triggered by the sudden downfall in trade data late last year.