China A-shares: four key factors for investors

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.

19. Aug 2020

China A-shares: four key factors (in 60 seconds)

  • China's A-share market is dominated by retail investors. Retail investors tend to have shorter holding periods, which can contribute to high levels of turnover and market volatility;
  • Investors can find a larger opportunity set of Chinese companies on the A-share market than on 'offshore' markets like the H-share market in Hong Kong and the ADR market in the US – particularly in fast-growing sectors like IT, healthcare and consumer;
  • Compared to overseas markets, China A-shares have low levels of both research coverage and correlation;
  • China A-shares can be a valuable addition to China multi-asset strategies since they offer diversification benefits, a wide opportunity set, and should benefit from increased investor flows coming from the inclusion of A-shares in global indices.

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)

Source: People's Bank of China, July 2020

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

Source: UBS, September 2019

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

Source: Bloomberg, January 2020

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

Source: HKEx, Top Foreign Stocks, 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)

Source: MSCI, Factset, data as of end April 2018

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

Source: Reuters Eikon; UBS HFS, as of 12 September 2019. Universe is based on companies with >=$500m market cap and >=$0.5m average daily turnover. Universe is based on stocks listed in Japan, China, United States, countries within MSCI AC Asia, countries within MSCI AC Europe. Analyst coverage is based on Reuters Eikon.

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.

Learn more about A-shares in our FAQ article here:

Global benchmarks: correlation to MSCI China A & MSCI World, Feb 2002-Nov 2019

Source: Bloomberg, December 2019

By Gian Plebani, Portfolio Manager, Investment Solutions

For multi-asset investors in particular, the diversification benefits from allocating to China's A-share market are considerable, and can offer a powerful offset to positions in offshore markets for China equities.

And that has been particularly true in 2020, where the A-share market has been a strong performer compared to other markets around the globe. 

In addition to diversification benefits, A-shares can be a vital part of a China multi-asset strategy because of the sheer range of investible opportunities available onshore.

And as the process of bringing China A-shares into global benchmark indices progresses, we believe that the implied inflows from the process will offer strong structural support for China A-shares over the longer term.

Putting all these factors together explains why we have been raising our allocations to China A-shares over the past two years, and why we continue to see opportunities in A-share markets in the future.

China multi-asset strategy: positioning over time, Jun 2015-Jun 2020

Source: UBS Asset Management, July 2020

Sources:


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