Inclusion of China A Shares into the MSCI Emerging Markets Index

Josh Crabb, head of Asian equities, Old Mutual Global Investors

The inclusion of China’s domestic  ‘A’ shares in the MSCI Emerging Markets index is a historic milestone along China’s path to open up its domestic financial markets and attract foreign capital inflows. While the move constitutes just 0.73% of the index, the importance of this latest action should not be underestimated. The anomaly that exists between China’s economic strength and stock market capitalisation, relative to its index weight, is finally starting to correct.

Investors in tracker funds (accountable for around US$1.6trn) will be obliged to buy the A shares when the rebalancing takes place in May 2018. While the process will be more gradual for active investors, they too, will have to consider realigning portfolios going forward.  We believe China’s domestic CSI 300 index trades on an attractive forward price/earnings multiple of 11.6 times, having significantly underperformed other major emerging indices since the start of 2016.

There are both short and long-term consequences of this move.  In the short term, the decision will act as a positive catalyst in terms of liquidity and, by implication, performance for China’s domestic shares. Over the medium to long term, it should reduce market fluctuations by increasing the participation by foreign institutional investors.  With a market capitalisation of US$7.7 trillion, the Chinese equity market is the second largest in the world, although remains underrepresented in major global indices.  Assuming eventual 100% A share inclusion, some market analysts are predicting approximately US$300 billion of incremental inflows, allowing China greater international accessibility and improved trading standards.  We expect, as investors start to understand Chinese companies better, that the valuation discount will start to reduce.