MSCI has finally decided to include China mainland companies in its MSCI Emerging Market benchmark. While some obstacles that have prevented China A-shares to be included in the past remain, many have been removed. As a result of the inclusion, A-shares stocks may benefit from short-term bet. We however believe that a credible reform agenda and adherence to it would be a stronger support for domestic companies over the longer run. China A-shares finally in after four attempts.
Yesterday evening, MSCI finally decided to include 222 A-shares stocks in the MSCI Emerging Market Index, an addition of 53 stocks compared to the 169 proposed, increasing the weight of the country in the benchmark by 0.73% (rather than 0.5%) to 28.4%.
The new proposal submitted yesterday has removed many of the obstacles from the original failed proposal discussed three years ago. Amongst other factors, the number of stocks has been trimmed down to 169 (proposed) from 448 as only large cap companies with the least liquidity issue were selected.
The implementation of a 5% inclusion factor from the index provider indicates that constraints remain on capital repatriation and foreign ownership limits. While full inclusion is still on the roadmap and while the Stock Connect system has increased confidence among foreign investors, China still has a long way to go as strict controls of the domestic capital markets are unlikely to be removed anytime soon.
Market participants have however welcomed the news whilst being cautious on the real impact of the inclusion on the valuation of China domestically-listed companies. A-shares price-to-earnings ratio relative to H-shares shows that A-shares is currently fairly valued with the relative PE ratio at 2.14 compared to its 1.92 median since 2008. So far this morning, there has been little reaction from the markets. We may see more movement once the US market opens later today.
With the size of the inclusion still representing a small proportion of the overall size of the Chinese market capitalisation, we believe a solid recovery of Chinese manufacturing PMI based on a credible reform agenda would be a stronger support for A-shares over the longer run.
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Edith is a director, multi-asset strategist at ETF Securities, specialised in investment strategies across commodity, equity, currency and fixed-income. Edith has 9 years of experience in the ETP industry, with exposure to different aspects of the business, from product management to research and investment strategy. Prior to joining ETF Securities, Edith started her career working for Lyxor Asset Management in Paris as Marketing assistant. Edith holds a Master in Management with a major in Risk and Asset Management from the EDHEC business school (France).
