- With the inclusion of 472 large- and mid-cap China A share companies in the MSCI Emerging Markets Index in 2019, China’s weight in the index rose to about 33% (from about 28% in June 2017).
- Trading liquidity measured by median annualized turnover ratio of index constituents increased significantly between 2017 and 2019, especially in the information technology and health care sectors.
- Inclusion of China A shares in the index might have also helped increase foreign institutional investors’ participation in China’s domestic equity market.
The emerging-market (EM) equity segment has evolved substantially during the two and a half years since MSCI announced the inclusion of China A shares in the MSCI Emerging Markets Index. Specifically, we found that emerging markets as an integrated allocation increased overall Chinese constituent companies, as well as sector exposure and liquidity and increased foreign participation.
Chinese companies gain significant index inclusion
China represented about 28% of the MSCI Emerging Markets Index in June 2017, roughly equal to the total weight of South Korea and Taiwan. With the 20% inclusion of 472 large- and mid-cap China A shares,1 China’s weight rose to about 33% of the index, as of November 2019. This was higher than the weight of South Korea, Taiwan and India combined. Additionally, China A shares’ weight in the MSCI China Index rose from nothing to about 12% in less than two years’ time.
In terms of risk contribution to the index, China’s contribution went up from 27.5% in June 2017 to 38.6% in November 2019 on an unhedged basis. Due to China A shares' historically low correlation to emerging markets, their risk-contribution share of the MSCI China Index and MSCI Emerging Markets Index has respectively been less than their market-capitalization shares.
This greater prominence of China in EM further bridges the gap of China’s market-capitalization weight and its GDP weight in EM.
The changing composition of the MSCI Emerging Markets Index
|Market-capitalization weight in 2017
|Market-capitalization weight in 2019
|Country risk contribution in 2017
|Country risk contribution in 2019
In the two charts immediately above, the inner circles display data in local currency, while the outer circles show risk in terms of USD. Data as of June. 30, 2017 (left side), and as of Nov. 27, 2019 (right side). Compared with the unhedged USD capitalizations and contributions, China’s overall risk contribution has been noticeably higher on a hedged or local-currency basis, due to the relatively higher risk contribution from EM currencies other than CNY and HKD versus the USD.
Including China A shares in the MSCI Emerging Markets Index narrowed emerging markets’ gap to developed markets in terms of the number of standard index constituents, as shown in the exhibit below. As a milestone event, the number of constituents in the MSCI China Index surpassed that in the MSCI USA Index for the first time post the November 2019 index rebalance.
The gap between the number of standard index constituents in EM and DM narrowed
Data as of Nov. 27, 2019
Sector scope and liquidity changes
The scope of sectors in EM was relatively narrow prior to the inclusion of China A shares. For instance, there were only about 40 stocks in the health care, real estate and communication services sectors in the MSCI Emerging Markets Index as of May 30, 2018. This sector scope greatly expanded with more than 60 standard constituent stocks in each of the 11 Global Industry Classification Standard (GICS®)2 sectors in November 2019 (see exhibit below). With the inclusion of China A shares, trading liquidity of EM index constituents increased significantly, especially in the information technology and health care sectors.
Sectors expanded and trading liquidity increased across EM sectors
Foreign institutions increased their participation in the A-shares market
The inclusion of China A shares in the MSCI Emerging Markets Index might have also helped increase foreign institutional investors’ participation in China’s domestic equity market.
The exhibit below shows that foreign investors’ participation in the market for China A shares has increased since 2017: Non-Chinese holdings of China A shares rose from USD 38 billion and 0.67% of the market total in December 2016 to more than USD 195 billion and 3.03% in September 2019.3 International investors’ increased influence was a factor in our observation that fundamental factors such as value and quality gained traction in China A shares strategies over the period examined.
Foreign investors’ holdings in China A shares in USD and as % of A shares’ total market cap
Investing in EM has historically been a bumpy ride. As the MSCI Emerging Markets Index included more China A shares their weight and contribution to the index increased along with the scope of sectors represented in the index, liquidity and participation of foreign institutional investors.
The author thanks Shuo Xu for his contribution to this blog post.
1 In March of this year, MSCI announced it would quadruple the amount of China A shares in its major benchmarks to 20% in 2019. See announcement here.
2 GICS is the global industry classification standard jointly developed by MSCI and Standard & Poor’s.
3 The launching and expanding of the Hong Kong-mainland Stock Connect program likely played a material role in the internationalization of China A shares. According to HKEX, due to MSCI inclusion, the number of segregated accounts in the northbound Stock Connect program rose from just over 1,000 in early 2017 to more than 9,000 in November 2019.