China's MSCI moment just the start

Thought of the day

by Chief Investment Office 31 May 2018

What happened?

Global index provider MSCI is adding China A-shares to its indexes starting 1 June, a major step toward global capital market integration for the country. The move, which has been in the works since 2013, will add 233 domestically listed Chinese stocks to the benchmark MSCI China and Emerging Markets (EM) indexes. This will come in a two-step process and by September, we estimate A-shares will account for about 0.8% of the MSCI EM Index.

What does this mean?

At a time of heightened US-China economic tensions, MSCI inclusion signals deeper Chinese links to the global financial system and a significant rise in foreign ownership of onshore Chinese equities. It is also an important step in the internationalization of the RMB, with further measures likely to open up its capital markets and support foreign investor inflows.

We expect inclusion to result in an additional USD 60bn of A-share inflows within the next 12 months, rising to more than USD 350bn within the next 3–5 years. At present, foreign capital accounts for less than 2% of the entire A-share market cap. If our five-year inflow estimate holds true, foreign capital will rise as high as 7% of the market cap. For many international investors, the MSCI change will add yuan-denominated stocks to their global portfolios for the first time.

What next?

While the initial impact on the entire A-market should be mild, we believe investors can position now to benefit from MSCI inclusion flows by investing in sectors most attractive to foreign investors. In particular, the consumer and healthcare sectors benefit from steady earnings growth, high returns, and healthy cash flows and dividends.

MSCI inclusion should also help dilute the outsized influence of more fickle domestic retail investors. We expect inclusion to nudge onshore Chinese firms to professionalize further, with improved reporting standards, board structures, and better corporate governance.

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