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Index inclusion delayed for China but positives abound

China is one of the world’s most dynamic economies and the opportunities for investors to benefit from its growth story are tantalising.

While there was a degree of disappointment at MSCI's (a leading provider of global indexes) recent decision to delay the inclusion of China A-shares in its emerging markets and other indexes, investors are keeping their eye on the bigger picture. The long-term impact of the latest delay is likely to be minimal. The momentum is on China’s side: it’s a matter of ‘when’ China A-shares are included and not ‘if’.

MSCI recognises progress and changes

As a long-term investor in China (we’ve been there since 1997 and were the first Australian institution to secure a Qualified Foreign Institutional Investor (QFII) quota), it was positive to see MSCI recognise the ongoing reform efforts in China and the progress that has already been made to make China A-shares more accessible for global investors. MSCI noted the ‘clear commitment’ by the Chinese authorities to bring the accessibility of China A-shares closer to international standards.

The improvements made during the last 12 months include the resolution of issues regarding beneficial ownership, trading suspensions and some capital mobility policies.

MSCI's announcement clarified areas requiring further improvements, such as the abolition of China’s quota system, liberalisation of capital mobility restrictions, and alignment of international accessibility standards. The 20% monthly repatriation limit of the prior-year net asset value remains a significant hurdle for investors that may be faced with redemptions, such as mutual funds. This must be satisfactorily addressed for MSCI inclusion.

How investors would benefit

Investors are already benefiting from the process towards inclusion. The moves undertaken by China to improve accessibility have made the China A-share market more efficient and attractive to international investors. The weighting in various indexes will be minimal to start, at about 5% of the China index, which equates to a 1.1% weighting in the emerging markets index.

Even a small initial partial inclusion will attract greater flows to the China A-share market, particularly from institutional investors. These investors, such as pension funds, are also more likely to invest for the long term compared with the local retail investors that make up the bulk of China A-shareholders. Retail investors are notoriously focused on the short term and, given their weighting in the China A-share market, this contributes to some of the market’s volatility. Diluting the retail shareholding will hopefully have the added bonus of making it a less volatile place to invest.

When a 100% inclusion factor is applied, China A-shares would represent approximately 18.2% of the emerging market index, according to MSCI, making it the largest constituent within the index, exceeding even Korea. But it will be a gradual process. For instance, it took six years for Korea to go from 20% to full inclusion and nine years for Taiwan to go from 50% to full inclusion.

Ultimately, MSCI has stated that the future pace at which China's partial inclusion factor is raised will depend solely on the development and further reform of the Chinese market. Given the speed at which China develops and the commitment towards addressing the remaining accessibility issues, China’s growth path may be faster than other countries.

China A-shares will remain on MSCI's 2017 review list for partial inclusion but it may happen sooner than June next year. MSCI has flagged it may bring forward a decision before the scheduled timeframe if significant positive developments occur ahead of time.


Patrick Ho is Head of Asian Equities at AMP Capital. This article is general information and does not consider the circumstances of any individual.



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