China's A-share market is one of the largest in the world but remains underinvested by global investors. Here we identify four key features of the A-share market and explain what benefits A-shares offer to asset allocators.
China A-shares: four key factors (in 60 seconds)
Though the China A-share market cap makes them the world's third largest equity market1|2, global investors remain underinvested, with China A-shares accounting for only 5.16% of the MSCI All Cap World Index3.
China A-shares – increasingly important
But times are changing.
Stock Connect has made the A-share market accessible, and the index inclusion process has added A-shares to global benchmarks in stages with different inclusion factors.
Now global investors are growing their onshore A-share holdings, but what do investors new to China's A-share market need to know?
Overseas Investors' China A-share holdings, Jan 2016-Jun 2020 (RMB Trillions)
Here are four key features:
1. China's A-share market is driven by retail investors
Starting from the investor base, the China A-share markets in Shanghai and Shenzhen are dominated by retail investors, who account for an estimated 80% of market turnover4.
Comparison of investor bases
Shanghai, Shenzhen & Hong Kong Stock Exchanges (% of Market), 2018
That means China's A-share space is quite different to other more developed markets, such as the US and UK, where larger, institutional investors are most dominant and who are, generally speaking, more fundamentally driven and who have longer term time horizons.
Compared to institutional investors, retail investors in China's A-share markets tend to have shorter holding periods, so they trade in and out of positions more frequently.
This can explain why China A-shares have much higher levels of volatility than other markets around the world.
High volatility can present a challenge for passive investors, but can create an opportunity for active strategies.
Active investors may capitalize on mispricing opportunities that result from periods of volatility. Such investors, focusing on fundamental, industry and company research, taking advantage of unconventional sources of information, and looking to identify long-term industry leaders can be rewarded in the China A-share market.
Retail investors in China's A-share markets tend to have shorter holding periods, so they trade in and out of positions more frequently.
This can explain why China A-shares have much higher levels of volatility than other markets around the world.
Annualized equity volatility: market benchmarks compared (USD - %), Feb 2002-Nov 2019
2. China's A-share market is large and offers more opportunities than offshore markets
In the China equity universe, China’s A-share market, including both Shenzhen and Shanghai markets, is clearly the largest space for investors.
Location of listed companies in the China equity universe, July 2020
More than size, China’s A-share market offers investors a much wider opportunity set.
This is clear when comparing the much greater number of stocks in the MSCI China A benchmark with the number of stocks in the MSCI China benchmark, particularly in fast-growing sectors like healthcare, consumer, and information technology (IT).
Though the MSCI China benchmark includes both onshore and offshore stocks, the majority are offshore.
As such, for investors looking for robust, diversified China exposure, they may be missing out on opportunities without an allocation to China A-shares.
Onshore/Offshore Markets compared (No. of Stocks)
3. China A-shares are relatively under-researched
China’s A-share market is comparatively under-researched, with almost 70% of companies being covered by three or less analysts, according to research by Reuters.
Additionally, only a small share of the total market, estimated at between 300 and 400 companies5, have English language coverage, which means the visible opportunity set for global investors remains small.
We believe these factors create opportunities for active managers with on-the-ground China capabilities to uncover underappreciated investment opportunities in the A-share space.
That's where our presence in China and our active, bottom-up approach to stock selection that uses 'on-the-ground' insights can make the difference. We believe this active approach can uncover underappreciated opportunities and create the potential to outperform competitors.
Analyst coverage of companies with USD 500m market cap, September 2019
4. China A-shares have low correlation to overseas markets
China A-shares have, over time, shown low correlation to overseas markets.
That's because of a number of factors, including low ownership by foreign investors, controls on investor access in the past, and the composition of the investor base.
Additionally, companies listed in China's A-share markets are more exposed to domestic, rather than overseas trends. This factor has been particularly telling in recent years, when concerns about US-China trade tensions have weighed on the prospects of companies with a high exposure to external trade and the US market.
It is possible that these factors will weaken over time, especially if - as expected - China's A-share market continues to open up and global investors grow their presence.
However, it will take time, and we expect that the low correlation of China's A-share market will continue for the foreseeable future and thus offer ongoing diversification benefits.
Global benchmarks: correlation to MSCI China A & MSCI World, Feb 2002-Nov 2019
Sources:
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