When MSCI announced that it will include A-shares in the MSCI Emerging Markets Index and the MSCI ACWI Index, Chinese investors reacted with excitement. And why not? The inclusion of A-shares in the MSCI could mean more than US$100 billion in flows to Chinese stocks in the next five years. 

Although the initial weighting is small, leading most Chinese analysts to predict only modest short-term effects, it is still a landmark step in the opening of China’s markets after three failed attempts to join the index.

New York-based index provider MSCI plans to add 222 China A Large Cap stocks, representing 0.73% of the weight of the MSCI Emerging Markets Index at a 5% partial inclusion factor.

“Given the limited number of A-shares to be added into the index, there will not be a large inflow in the short term,” says Hanfeng Wang, managing director of CICC. “Some stocks have seen consistent growth since the start of 2017, so there is a positive effect, but it is more of a long-term effect.”

Analysts from securities companies share similar views: “Compared to the current US$7 trillion market size of the A-share market, the short-term inflow will be limited,” says Shaojun Li, chief strategist, at Guotai Junan Securities. “The inclusion will be a blueprint for the market, which will drive other mainstream indices to include the ‘China element’”. The potential inflow to the A-share market in next five years will exceed US$100 billion, adds Li.

The recent inclusion by MSCI is the fourth attempt to join the index. “Thinking deeply, the core reason for success this time is that overseas investors are aware of the significance of the A-share market in global asset allocations. We have seen growing interest from overseas investors to buy A-shares over the past few years,” says Lifeng Li, strategist at Sinolink Securities.

“China’s domestic A-share market is the second largest stock market in the world. Across the Shanghai Stock Exchange, Shenzhen Stock Exchange and Chinext, it is home to a range of blue chip stocks representing well-established business models with strong pricing power and robust cash flows,” notes Jing Ning, portfolio manager at Fidelity International.

“Many of these companies are also exploring international markets, expanding their product lines and entering new market segments, but this is not widely recognised. So far, this market is dominated by retail investors who are influenced by short-term swings in sentiment as well as willing to overpay for growth levels that are not sustainable over an economic cycle.”

The significance is not lost on international investors either: “China’s A-share market has simply been too big to be overlooked by global investors. It is the second-largest equity market in the world, both in terms of market capitalization and turnover,” comments Matthews Asia China Investment Team.

“In recent years, we have witnessed the evolution of China’s A-share market – not only in terms of the number of listed companies, which has been growing substantially, but also in overall quality.”

"As the global economy shifts from West to East and China continues to progress its renminbi internationalisation agenda, more international investors will recognise the immense investment opportunities China offers and gradually start getting and increasing exposure to the country in their diversified portfolios," adds Bill Maldonado, Asia-Pacific CIO as HSBC Global Asset Management.

"The Chinese equity market offers unique opportunities across sectors including technology and “new economy” stocks which we believe are key growth contributors to our Chinese equity portfolios."

Further representation on the index is likely to hinge upon regulatory reform, says Remy Briand, MSCI managing director and chairman of the MSCI Index Policy Committee, in a statement announcing the decision: “When further alignment with international market accessibility standards occurs, sustained accessibility is proven within Stock Connect and international institutional investors gain further experience in the market, MSCI will reflect a higher representation of China A-shares in the MSCI Emerging Markets Index.”

Reacting to the news, Xiaojun Zhang, spokesperson at the Chinese Securities Regulatory Commission (CSRC) comments, “MSCI’s decision to include A-shares in its index is both an opportunity and challenge for the Chinese capital markets. We believe that we should stick to market reforms and boost the development of the capital markets.”

“We will protect the investors and continue to strengthen our capability to serve the real economy. CSRC will strive to improve regulations for overseas A-share investors to better cater to their needs of investing in A-share products such as those tracking the MSCI index.”

“Conservatively speaking, we think the full inclusion will still take 5-10 years, depending on the progress of China’s capital markets liberalization,” says Victoria Ho, co-head Robeco Asia Pacific equities. “If reforms progress is faster than currently anticipated, we are likely to see significant increase of inclusion factor in 3-5 years, similar to the case of Korea market.”

Photo credit: Frame China / Shutterstock.com