China’s US$8 trillion domestic equity market flying onto the investor radar

On the eve of Prime Minister Justin Trudeau’s four-day visit to China, New York-based money manager Alliance Bernstein held a series of seminars across Canada this week on investment opportunities in the world’s second-largest economy.

And, according to John Lin, a Hong Kong-based Alliance Bernstein portfolio manager who invests in Chinese equities, those opportunities will grow as China continues to open up both its economy and financial markets to outsiders.

One number was staggering: the domestic Chinese stock market — which is only available to a limited number of outside investors, specifically the large non-Chinese institutions who have received approval to participate — is home to almost 3,200 issuers. Those issuers have a market cap (as of Sept. 30) of US$8.05 trillion. That market is known as the A-shares.

At that level, the market is more than three times the total value of those Chinese companies that have listed in Hong Kong and more than 10 times the size of the Chinese companies that have used ADRs (American Depository Receipts) to list on NYSE or Nasdaq.

“When was the last time in anyone’s investment career that a US$8 trillion market (all of a sudden) moves onto the radar screen?” asked Lin.

China A-shares

Another way to view that number: companies listed on the TSX have a market cap of about $3 trillion, meaning the A-share market is more than three times as large as Canada’s — even if some of the characteristics are different from what occurs here. For instance, investors have a very short-term focus, daily turnover is massive, and retail investors and not institutions, dominate. “The (mutual funds) turn over their portfolio managers as quickly as they turn over their stocks,” said Lin, declaring China A-shares is the world’s “most inefficient market.”

What makes China’s A-shares so topical is that in June 2018, some of those A-shares will be included in the Morgan Stanley Capital Index emerging markets (EM) index, a popular benchmark against which money managers are rated. (The non-domestic China shares currently have a 28.6 per cent weight in the EM index. The A-shares will also be included in the MSCI all country world index.)

That decision was announced last June. MSCI said the decision reflects, “the positive impact on the accessibility of the China A market … and the loosening by the local Chinese stock exchanges of pre-approval requirements that can restrict the creation of index-linked investment vehicles globally.”

MSCI plans to add 222 companies at a 5 per cent “partial inclusion factor” which will give the A shares a 0.73 per cent weight in the overall EM index. With a full inclusion of the 222 stocks the weight of the A-shares would rise to 12.8 per cent.

“It’s a matter of time. It’s going to happen,” said Lin noting the inclusion news is significant because the A-shares have a different profile than other China shares.

“Investors getting their China exposure solely through the offshore market are missing out on diversification benefits,” he said when referring to different sector weights (technology, for example is about 40 per cent of the offshore market but 10 per cent of the A share market), the different type of investors and the different multiples that apply in the two markets.

Without A-shares, Lin said, investors “won’t be getting exposure to the middle class consumption growth, (and) to aging demographic and the need for health care.”

Investors that want to participate in that market now have seven months to find a way.

Financial Post

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