Market comment: A good first step: more China stocks in MSCI indices

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The addition of Chinese A-shares to the MSCI Emerging Markets Index is positive for investors, says Annemijn Fokkelman, ABN AMRO Global Head of Equities, but some caution is still required.

After three years of debate and consultation, MSCI, the global index provider, is adding Chinese A-share stocks to its emerging markets index. This year, what had become an annual proposal was successful. Agreement came after MSCI scaled down the suggested number of stocks by around half (compared with last year’s proposal) and steps were taken to ensure investability and to minimize liquidity risk.      
As announced last night, starting in June 2018, the MSCI Emerging Markets Index will be expanded to include 222 Chinese mainland stocks. These stocks are known as A-shares, which are the shares of mainland China companies, denominated in the renminbi. Until recently, these shares were only available for purchase by mainland citizens.

A positive first step
“The addition of these A-shares to the MSCI Emerging Markets Index is an important first step,” says Fokkelman, “and an indicator that Chinese capital markets are coming in line with international standards.” In the short-term, she expects more positive investor sentiment for China, but expects little impact on global markets. This is because the addition of the A-shares will initially represent just a 0.73% of the index, based on market cap. More impact is expected in the future, when the number of A-shares is likely expanded.

Capturing the growth in Asian emerging markets 
Against a background of a global synchronised recovery, low interest rates and projected double-digit earnings growth, ABN AMRO is positive on equities, and favours emerging markets Asia and European equities over other regions. This is owing to encouraging earnings momentum and a pronounced valuation gap with the US.

And, while there have been signs of a slowdown in China, economic growth in emerging markets Asia is expected to be around 6% in 2017, which is much higher than for most of the rest of the world.

To capture the high economic growth in emerging markets, Fokkelman suggests investing in diversified Asian equity funds, rather than individual mainland-listed Chinese companies. This is because Chinese corporate governance is currently not at international levels. These stocks can be volatile and investing through a fund will reduce stock-specific risk. In time, however, as the Chinese A-share market matures, she believes it will be worthwhile to reconsider taking positions in individual A-share stocks.

Despite this caution, Fokkelman is positive over MSCI’s decision. “The move confirms our view that Asian emerging markets and China, in particular, are engines of growth.”