MSCI’s recent announcement that it will add 222 China A shares to its key benchmarks raises practical questions for global and emerging market investors: How does it affect their investment policy? How can they implement these exposures (whether or not they already have China A shares in their portfolios)? While inclusion of China A shares is a year away, institutional investors may want to start planning for how this change may affect their portfolios.
Longer term, if China continues to liberalize the A shares market and MSCI were to fully include them, China’s weight in the MSCI Emerging Markets Index could rise to 40.8% from 28% currently, as we see in the exhibit below.
China A shares Index Weight
Based on data as of June 19, 2017
How to respond to A shares benchmark inclusion may depend on whether investors already have exposure to A shares. For global institutional investors without current A shares exposure, the key is to address their policy allocation to emerging markets, including China. Such a reevaluation can help reflect their long-term risk and return preferences more accurately.
Global institutional investors who already have an off-benchmark allocation to China A shares face potential benchmark misalignment with their existing A shares allocations. In addition, they may want to consider whether to retain or switch their A shares specialist allocation to a generalist emerging market or global manager. In this process, China A shares specialist managers may have an advantage because of their longer track records and because not all emerging market and global managers may be ready to manage China A shares.
The challenge for A shares specialist managers, however, will be to demonstrate that their investment processes are aligned with investor beliefs and that they can demonstrate stability and persistency in performance. While generalist managers may have less experience investing in China A shares, they may be able to point to better conformity with asset owner beliefs and benchmarks, and less volatility in their ability to deliver excess returns over time.
With or without a current A shares exposure, global institutional investors may want to examine how ready their current emerging market and global equity managers are to handle the inclusion of A shares in their benchmarks. In particular, it helps to understand if managers have a clear insight on the pros and cons of different access paths, sources of risk and return (including differing sector compositions), macro drivers, the premium or discount between A shares and H shares, style factors and other idiosyncratic drivers of China A stocks.
A shares Inclusion: A framework for institutional investors
The author thanks Chin Ping Chia for his contributions to this post.