Samenvatting
The MSCI China A-Shares inclusion, which officially started on 1 June 2018, means the China A-Shares market is more relevant for global investors than ever. But why should a global investor buy into China A-Shares, given they already have exposure to China through existing allocation to emerging markets / Asia? We examine how China A can fit into investors’ portfolio now, and in the future.
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Key takeaways
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China equity is not a new concept for emerging market participants. Today, China equities account for around 30% of the MSCI Emerging Market Index (“MSCI EM Index”) and 35% of the MSCI AC Asia ex Japan Index1. And these index levels will surely increase. On 1st June 2018, MSCI included China A-Shares into its emerging market indices for the first time. This article assesses the likely long term impact on investor future allocations to China and concludes that as a first step adding China A shares can help improve risk / return profiles. Over the longer term, we expect more investors are likely to decide to allocate to China as an asset class in its own right.
Current China exposure: high concentration, low growth
Let’s take one step back and examine the current typical China allocation in global investor portfolios. Most investors gain exposure to China through global emerging market and/or Asian equity strategies. The 30% China exposure in the MSCI EM Index comes from around 150 China constituents. But around 1/3 of this weighting is dominated by the three internet giants - Tencent, Alibaba and Baidu (“BAT”). Another 40% comes from the old economy sectors such as banks, telecom and utilities, which are dominated bylarge, state-owned enterprises. As a result, China exposure in the MSCI EM Index has a very clear mega cap bias – around 1/2 is dominated by just ten benchmark heavyweights each with a market cap above USD 100 bn. (Chart 1)
Chart 1: China: exposure in MSCI EM Index
Will MSCI China A-Shares inclusion in EM indices help dilute such high concentration? Not in the near term. With only 5% inclusion factor in 2018 – 2.5% on 1 June and 2.5% in September - China A’s weighting in MSCI EM index will be very small at around 0.8%2
China A – structural growth, improved diversification
China A-Shares are Chinese stocks listed on the Shenzhen and Shanghai Stock Exchanges, and traded in Renminbi. They consist of more than 3500 listed equities equivalent to around USD 8.6 trillion market capitalisation3. Of these, around 1500 China A-Shares companies can be easily accessed through the widely-used stock connect schemes.4
Chart 2: China A Shares - number of stocks by sector
In addition to the size of the opportunity set, China A-Shares offer a much more diverse universe for investors, especially in structural growth areas such as consumers, industrials, IT and new materials. For example, there are 322 industrial and consumer stocks within the MSCI China A Onshore Index. This is compared to only 49 in the offshore China exposure of MSCI EM Index. (chart 2) Most of these stocks are unique to China A-Shares, including Chinese spirit brands with a market cap bigger than Diageo; pharmaceutical companies providing diabetes treatments for the aging population, and other names related to areas such as electric vehicle, environment monitoring and IT infrastructure.
Chart 3: China A Shares— market cap breakdown
Source: Bloomberg, Allianz Global Investors, as at 30 April 2018.
China A-Shares can also help EM investors diversify away from mega caps. Approximately half of the MSCI China A-Shares Onshore Index is represented by companies with a market cap below USD 10 bn. The equivalent number is only 10% in offshore China (chart 3).
Why invest into the ‘new economy’, smaller cap companies? One intuitive answer is that these opportunities represent the future drivers for China’s economic growth - consumption, technology and innovation. More than half of China’s GDP is contributed by services. China is a major investor in and one of the world’s leading adopters of digital technologies, especially in the consumer space. And this rich digital ecosystem expands beyond just a few giants, such as Tencent and Alibaba - China is home to one third of the world’s unicorns, that is privately owned companies with more than USD 1 billion market cap5.
China A – Risk/return enhancement to an EM portfolio
China A shares have some further characteristics which make them very different from the typical China exposure you might get in an EM portfolio. More than 90% of the revenue of China A-share companies is domestic driven6 and therefore relatively less sensitive to global macro trends. In addition, China A-share markets are dominated by domestic retail investors, who are typically short term and momentum driven. They therefore behave very differently from global institutions. These elements combined have resulted in a low correlation between China A-shares and the rest of the world. The historical correlation between China A and MSCI EM Index is less than 0.4, meaning 60% of the time these two asset classes move in different directions7.
Chart 4: Risk Return Profile: EM + Allianz China A Shares— market cap breakdown
Source: Bloomberg, Allianz Global Investors, as at 30 April 2018. Hybrid portfolio is calculated using monthly return from MSCI EM Index and gross return of Allianz China A-Shares on a USD basis, assuming monthly rebalancing.
As a result, from a portfolio construction perspective, adding China A-Shares can potentially enhance the risk / return profile for an Emerging Market equity portfolio.
The back test above shows that adding Allianz China A-Shares into an EM portfolio would not only have improved returns but also reduced the overall level of volatility (Chart 4). The same analysis shows similar results using MSCI AC Asia ex Japan and MSCI ACWI Indices8.
Chart 5: China A-shares - weighting in MSCI EM Index
Source: MSCI, Bank of America Merrill Lynch, Allianz Global Investors, as of May 2018. Middle chart is based on MSCI’s proposal in May 2018 to include 233 large cap China A-Shares stocks into MSCI Emerging Market Index. Right chart is based on the assumption that all China stocks are available to be included in MSCI Emerging Market Index. We use a 85% discount factor – which should approximately represent the large and mid cap universe within China A-Shares.
Long term implications of China A-Shares inclusion
Over the coming years, it is very likely that the China A-Shares weighting in the MSCI EM Index will increase significantly to reflect the size of A-share markets. And an emerging market portfolio of the future will therefore likely look significantly different from today.
Assuming a 100% inclusion factor of large and mid cap stocks listed on the Shanghai and Shenzhen stock exchanges, China A-Shares would rise to 28% of the MSCI EM Index. This combined with offshore China means 50% of the MSCI EM Index would be represented by Chinese equities (chart 5).
Many active investors have already started positioning for this structural change. In May 2018, purchases of China A-shares through the stock connect schemes reached a historical high of RMB 51 bn (~USD 8 bn)9. Since the launch of the Shanghai stock connect in late 2014, there has been cumulative buying of RMB 485 bn (USD 76 bn) into China A-Shares. Despite this step change, foreign investors still only own around 2% of the total China A share markets10.
From our own experience a growing number of foreign investors are choosing to access China A-Shares as a strategy separate to their emerging market allocations.
Our view is that over time, the natural next step is for investors to allocate to China - both onshore and offshore combined - as a separate asset class when it becomes too dominant in EM indices. This would be consistent with the way global investors allocate to other dominant economic regions such as the US, Europe and Japan.
Active is…Two ways to access China A-Shares
Allianz Global Investors has extensive experience researching and investing in China A shares. Based in Hong Kong, we launched our first dedicated China A share strategy in 2009. We use a fundamental, active, bottom up approach with a philosophy that it pays to be highly selective.
Depending on investor preference and approach to allocating to China we offer two main strategies to access China A-Shares markets:
- Allianz China A-Shares - a strategy which invests in stocks listed in Shanghai and Shenzhen.
- Allianz All China Equity - a strategy which balances onshore and offshore China equity exposure.
1. Source: Bloomberg, Allianz Global Investors, as at 30 April 2018. 2. Source: MSCI, as at May 2018. Estimation based on 5% inclusion factor of 233 China A-Shares large cap stocks. 3. Source: Bloomberg, Allianz Global Investors, as at 31 December 2017. 4. Source: Shanghai Stock Exchange, Shenzhen Stock Exchange, as at 4 June 2018. 5. Source: McKinsey Global Institute, Digital China: Powering the Economy to Global Competitiveness, as at December 2017. it is not a recommendation or investment advice to buy or sell any particular securities and should not be considered investment advice. 6. Source: Nomura, as at September 2017. Estimation is based on CSI 300 Index. 7. Source: Bloomberg, Allianz Global Investors, as at 31 March 2018. Correlation data is calculated based on historical weekly USD return of MSCI EM Index and MSCI China A-Shares Onshore Index. 8. Source: Bloomberg, Allianz Global Investors, as at 30 April 2018. Hybrid portfolio is calculated using monthly return since March 2009, based on gross returns of MSCI ACWI Index, MSCI AC Asia ex Japan Index and Allianz China A-Shares on a USD basis, assuming monthly rebalancing. 9. Source: Haitong International, as at 31 May 2018. 10. Source: Goldman Sachs, ’A’ primer for global investors (second edition), as at 16 May 2018 Grassroots® Research is a division of Allianz Global Investors that commissions investigative market research for asset-management professionals. Research data used to generate Grassroots® Research reports are received from independent, third-party contractors who supply research that, subject to applicable laws and regulations, may be paid for by commissions generated by trades executed on behalf of clients.
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Key takeaways
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