MSCI A-share inclusion only “symbolic” after concessions

MSCI has confirmed it will include China A shares in its emerging-market indexes from June 2018 – but the long-awaited move is only symbolic in light of certain concessions, say asset managers.

The decision, announced earlier this morning (Hong Kong time), comes as the index provider took the unusual step of softening its stance on several conditions to enable a partial inclusion.

MSCI will admit a smaller number of stocks than originally planned, while eliminating stocks that have been suspended for an extended period. In the first phase, 222 China A Large Cap stocks will be included (rather than 448). This means mainland shares will represent 0.73% of the weight of the MSCI Emerging Markets Index.

Fund managers welcomed the moves, but with several caveats.

Modified admission criteria

Nicholas Yeo, head of China and Hong Kong equities at Aberdeen Asset Management, told AsianInvestor: “The interesting thing was that instead of requesting the Chinese government to address the impediments to inclusion such as ownership rights, capital repatriation, trading suspension [levels], MSCI has modified its own admission criteria.”

The progress made on Stock Connect and the fact that active managers are using the northbound channel to access A shares in any case, may have pushed MSCI to force the issue on inclusion, he said.

Daniel Morris, senior investment strategist at BNP Paribas Asset Management, noted: “They scaled back the ambitions quite a bit, so it’s really more of a symbolic significance than a practical one in terms of the performance of the index. It makes it easier for them to include China, because it’s going to be less significant in terms of how it will affect portfolio investors.”

MSCI said the decision had received broad support from international institutional investors. Remy Briand, chairman of the MSCI index policy committee said: “The expansion of Stock Connect has been a game changer for the market opening of China A shares.”

He added that international institutional investors viewed Stock Connect as a more flexible access framework than the current QFII and RQFII regimes. But investors continue to view the number of suspended shares in China as “an outlier” compared to other international markets, he noted.

Change of tack

In MSCI's review last year, it noted that while mainland authorities have made several improvements to the accessibility of A shares by global investors, the changes were not sufficient to justify inclusion. The index provider had said that it was unlikely to be another year before inclusion took place.

Speaking to AsianInvestor last October, MSCI chief executive Henry Fernandez said: “We are very optimistic that the reforms that are taking place are going to help us continue to look at this favourably.”

But he made it clear that the onus was on Beijing to make the necessary reforms, not on MSCI to lower its standards.

That stance changed however, as negotiations continued into 2017, with the index firm signalling a willingness to concede certain points and modify the criteria in some areas so as to include China.

A total of $1.5 trillion in assets ($0.2 trillion in passive funds and $1.3 trillion in active products) track MSCI EM indices, according to Goldman Sachs. The 0.73% weighting for China will bring around $10 billion into mainland equities.

Portfolio implications

There will be some rebalancing of portfolios necessary in the wake of this decision, but most fund managers consider it is not going to be that significant. BNP’s Morris said, “It’s just 0.73% so it’s not going to be a massive change, and some portfolios will have anticipated this.”

Yeo agreed: “I don’t this will move the needle much. It’s more a symbolic gesture, but it sets the tone for future increments, because it’s not going to stay at this level [0.73%] for long.

“Active funds, if they were already invested or if they want to be in China, would have already done so through QFII, RQFII and Stock Connect,” added Yeo.

Index and exchange-traded funds will have to buy assets that represent the new allocation to China.

For active managers, it will depend on how their benchmark is defined. “If your benchmark is only MSCI EM, then it now becomes a universe you’ve got to consider and decide whether you want to overweight or underweight these stocks,” said Morris.

“If you can go off-benchmark, you may already have looked at these stocks,” he added. “Nonetheless, if up to now you’ve only been looking at the H-share market, it is a different beast to understand the dynamics of the A-share market. It’s driven to a large extent by the behaviour of domestic retail investors.”

Yannan Chenye, head of China equities research at Harvest Global Investments, said the decision to include China would result in a more balanced investor structure with a higher proportion of institutional investors and, probably, in a change of investment style in the A-share market.

Meanwhile, MSCI has also reclassified Pakistan as an emerging market rather than a frontier market and launched a consultation on whether to include Saudi Arabia in its emerging markets indexes. It will announce a decision on the latter in June next year.

AsianInvestor will host its 4th China Global Investment Forum in Beijing on September 21. Click on the link for more details.