Managers divided over MSCI A-share prospects

Market players are divided over whether MSCI will include China A shares in its emerging market index, when it makes its annual announcement tomorrow.

If the global indices provider follows in the footsteps of its rival FTSE and includes A shares, it will be seen as a bold move from a conservative company.

But market observers said that even if MSCI doesn’t make the move tomorrow, it was likely to happen at some point in the second half of this year.

The US-based index provider will announce its decision on Wednesday, June 10 at 5am Hong Kong time (5pm New York time on Tuesday, June 9).

Fund managers have mixed views on the possible inclusion, with supporters saying A-share purchases are already possible and that a positive MSCI move would provide more equity options.

Industry participants such as Ashley Alder, CEO of Hong Kong’s Securities and Futures Commission, and Chia Chin Ping, MSCI’s Asia research head, said the inclusion was not a question of if, but a question of when. The question is, is this week the time?

“The timing is just not good,” said an industry source who declined to be named. “MSCI will not take those programmes which have not yet been implemented into consideration - the mutual recognition of funds will only happen in July and Shenzhen-Hong Kong Stock Connect has not been announced yet.

“My guess is that MSCI will not announce the inclusion of A shares this week, but it is likely to happen in the second half, given that Shenzhen-Hong Kong Stock Connect will go live in the second half,” the source said.

In January this year MSCI announced that overseas-listed Chinese stocks such as Alibaba and Baidu will be included in its benchmark China index in November 2015, meaning the index provider has flexibility for A-share inclusion which would not need to be delayed until next summer, he added.

MSCI last month said it would adopt a flexible stance when it came to A-share inclusion, saying its June-to-June consultation timetable was mainly for transparency and predictability.

"The upcoming [China] policy changes in the second half are likely to be very significant,” said Qi Wang, Hong Kong-based founder and CIO at Forward Capital Group. “It may prompt MSCI to delay the decision to later this year in order to accommodate the policy implementations, such as mutual recognition and the expected Shenzhen-Hong Kong Connect.”

MSCI initiated a review of China A shares in 2013 with an eye to a potential inclusion in global benchmarks, which would start with a 5% weighting in the EM index. The firm kept China waiting for emerging market status last June, mainly due to accessibility issues such as capital repatriation restrictions under the RQFII and QFII schemes, lack of alignment between quota allocation and investors’ size, and uncertainty over capital gains tax (CGT).

While China has launched multiple cross-border schemes over the past 12 months, and clarified CGT issues on Stock Connect, RQFII and QFII, it might not enough for MSCI to support an inclusion.

“MSCI will make the decision, but its role has been passive,” the industry source said. “Its decision depends on China’s openness and global investors’ feedback.”

Market participants have said it is 50-50 whether A shares will be included this year, and sell-side research analysts such as JP Morgan and Morgan Stanley have stated it is not likely to happen this week.

Fund managers also have mixed views.

Schroders is not optimistic about an inclusion this year. David MacKenzie, Hong Kong-based head of Asian equity management, expects MSCI to announce the inclusion in 2016 with implementation in 2017. However, this will be dependent on Shenzhen Connect going live and the removal of trading quota limits on the Connect schemes.

Kenrick Leung, Hong Kong-based Greater China equities investment director at Amundi, said his firm would welcome an inclusion because it has already built an A-share investment team. He said he supported an inclusion because it could create a bigger investment universe, making more stock choices available for managers.

Mark Mobius, executive chairman of Templeton Emerging Markets Group, said he would support an A-share inclusion. “We believe the prospects are very bright for the China market (both A and H) as more and more investors from around the world become more interested in these markets,” he said. Mobius manages global emerging market investments with an AUM of $40 billion.

MSCI could disappoint or surprise the market this week, but China has become a market too big to ignore. Market observers have said A shares will be included sooner or later, and as a result foreign investors have had to prepare for when and how to invest in China’s onshore market.

“Vanguard's recent decision to adopt FTSE's inclusion index suggests large institutional investors are already moving ahead,” said Qi Wang.