An ACE approach to China equities

China's equity markets are changing and an All-China Equity (ACE) approach offers a way to stay ahead of the game.

30. Apr. 2019

- International investors' participation in China's equity markets has increased.

- Financial reforms have opened up China's onshore stock markets more and the distinction between offshore and onshore equity markets is becoming increasingly irrelevant;

- An All-China Equity (ACE) approach combines on- and off-shore opportunities, offers investors a range of benefits, and looks likely to be the best way of capturing China's ongoing growth story.

China's equity markets are seeing more global investors

When overseas investors ploughed a net RMB 125.4 bn (USD 18.7 bn) into China's onshore equity markets via Stock Connect in Q1 20191, something unprecedented was going on.

Stock Connect in Q1 2019 were also the highest quarterly total recorded on the Stock Connect program. Up almost three times the RMB 42.1 bn recorded in Q1 20182, net stock purchases on the Northbound

That's partly because sentiment improved. Policy support, low valuations, potential resolution of US-China trade tensions, plus increased inclusion of A-shares into MSCI's global indices brought investors back to markets.

China onshore markets are more accessible following reforms

But a much more fundamental trend has been playing out: namely, the shift of global capital into China made possible by the opening of onshore equity markets.

Stock Connect programs launched between Shanghai and Hong Kong in November 2014 and expanded to link Shenzhen and Hong Kong in December 2016 have opened onshore equity China markets to overseas investors.

Since January 2016, overseas investors have funneled RMB 680bn (USD 101bn) into China equities3 via Stock Connect.

Net Monthly Northbound Flows on Stock Connect (3 & 6 Mth Moving Averages – RMB Bn), May 16-Mar 19

Source: Hong Kong Exchange, April 2019

A breakthrough from the past

These changes mean a meaningful breakthrough from the past.

Prior to Stock Connect, foreign exchange controls limited investor access by imposing investment quotas and lock-up periods to only qualified investors.

In contrast, all investors got direct access to offshore listed stocks like H-shares and P-chips in Hong Kong.

In the past, investors looked at China equities based on whether they were listed either onshore or offshore, and invested accordingly, perhaps through either an onshore-focused fund, or an offshore focused fund.

All-China Equity – capturing some of the best China equity opportunities

Now that onshore markets have opened up more, the distinction between onshore and offshore markets is becoming increasingly irrelevant, and investors can look at China investing with an All-China Equity approach and allocate to whichever market offers the best opportunities.

The benefits of an All-China Equity approach are numerous but three, in particular, stand out because investors can:

  1. Access a wider opportunity set: 3,560 companies trade on onshore China equity markets, compared with 1,322 companies trading on offshore markets5;
  2. Combine high-growth sectors: onshore markets have more companies in fast-growing healthcare and consumer sectors, while offshore markets have a big selection of innovative tech and services companies;
  3. Diversify risk: China A-share markets have low correlation to other global markets6, so they are less affected by changes overseas;
    Looking longer-term, an all-China approach also makes sense from a strategic point of view.

China is driving the world economy - contributing 33% of global growth in 20196, but is only 3.7%7 of the MSCI World Index. That means the world remains underinvested in China.

The challenge for investors then is how to capture the growth and, given China's weight in the world economy, a standalone allocation using an All-China Equity approach could make sense.

That's because an All-China Equity approach combines on- and off-shore opportunities, offers investors a range of benefits, and looks likely to be the best way of capturing China's ongoing story. And that's something investors should definitely consider when planning a China strategy.

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