On June 20, 2017, MSCI announced as part of its Annual Market Classification Review that it will include China A-shares into its global equity benchmarks. Here are three things to know about China’s inclusion in global equity indices.
This is a watershed event. We believe China’s strategy is to create more portfolio inflows into the country, which may help balance capital outflows—the world diversifies into China as China diversifies outward. Inclusion of A-shares in global equity benchmarks are a critical step in the process. In the near-term, portfolio inflows are likely to be modest given the limited initial A-shares weighting of 0.73% in the MSCI Emerging Market Index (China’s total country weight is 27.7% counting all share classes1). If China continues its market reform, that weighting could grow significantly over time: on full inclusion, MSCI estimated an 18.2% weighting for A-shares and more than 35% for China overall.2 Full inclusion could take a number of years given the size of China’s market and the constraints on market access and capital mobility that still need to be addressed. But we believe inclusion in global equity indices is a major step in China’s longer-term strategy and that inclusion of China’s bonds in global fixed income indices will be another important step.
China’s domestic demand should become a bigger driver of EM equity markets. The broader A-shares market and the initial 222 stocks to be included into MSCI indices remain tilted towards “Old China”, including manufacturing and state-owned enterprises (SOEs). Over time, the “New China” segments of the market—those oriented to the strengthening consumer, rapidly aging population, and continuously evolving domestic consumption patterns—may grow, both in terms of their share of China’s equity market and their influence on broader EM equity market performance.
China’s domestic equities offer a unique combination of potential opportunity and risk. Global investors have generally focused on China’s offshore H-share market rather than the domestic A-shares market. Investors should be aware of the heavy weighting of SOEs in the A-shares market. Many SOEs have significant debt and operate in segments of the economy that could be at risk of overcapacity. On the other hand, China’s domestic market includes a huge number of small- and mid-cap stocks that are often not included in major benchmarks. We continue to focus on companies with robust organic demand growth, credible long-term business strategies, and sound management execution and we see attractive potential opportunities in the Health Care, Information Technology, and Consumer sectors at the company level.