MSCI Market Reclassification: What’s Next for China?
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MSCI Market Reclassification: What’s Next for China?

Author: Angela Rhoden

June 22, 2017

In a milestone event for China’s capital markets, MSCI announced on June 20th that it will add 222 mainland Chinese stocks to the MSCI Emerging Markets Index (EM). The rebalancing will occur in two stages, starting in May 2018 (inclusion factor: 2.5%) and again in August 2018 (inclusion factor: 5%) with A-shares expected to account for approximately 0.7% of the MSCI EM by August 2018.

Market Reaction

The initial market reaction was positive with Shanghai Composite and the Shenzhen Composite (A-shares) closing 0.5% and 1.2% higher, respectively, on the day of the announcement. However, the Hang-Seng Index (H-shares), currently the only China index included in MSCI China, closed 0.6% lower. Other Asian markets also moved modestly lower following the announcement with the Nikkei down 0.5%, the Kospi Index down 0.5% and the ASX 200 Index down 1.6%.

Implications

In the short-term, the impact to global investors is expected to be fairly muted, given A-shares will account for approximately 0.7% of MSCI EM in 2018. However over the longer-term, this development should not be ignored. Taking from the experience of South Korea and Taiwan, China A-Shares could obtain 100% inclusion within a 5-10-year timeframe, and therefore grow from 0.7% of MSCI EM in 2018 to as high as 17-18%. This would take China’s weight in the overall EM index to close to 40%.

Chart showing China's current weight and effects under new proposal - increasing weight relative to other EM countries.

Source: CIMB, Bloomberg as of June 21, 2017

That said, it will be incumbent upon China to improve accessibility to the A-share market to international market accessibility standards in order to gain full inclusion. There are three preconditions that must be met: 1) significantly increase the daily quota limitation for Stock Connect from the current $4 billion; 2) lower the number of stocks with trading suspensions from the current 7%; 3) implement corporate governance reforms.

AGF Investments’ View

In our view, the decision to include China A-Shares in the MSCI Index is not surprising, given the recent support of some of the world’s largest asset managers. It does reflect the fact that China is too big to ignore for global investors, as the 2nd largest equity market and 3rd largest bond market. China could arguably be an asset class of its own, similar to the U.S. within the developed market context.

More importantly, inclusion of China A-Shares expands opportunities for global investors to invest in a vibrant domestic consumer and services in China. The A-Share market has greater exposure to the Consumer Staples, Financials and Industrials sectors relative to MSCI China (depicted above) and therefore expands the opportunities available in these sectors. It is also worth highlighting the higher cyclicality of the A-share market with 65% exposure to the top cyclical sectors (Financials, Energy, Industrials and Consumer Discretionary) compared to 45% exposure for MSCI China.

Finally, we expect that opening up the China A-share market will lead to higher capital inflows from international investors and in turn drive corporate reform. This is because, as the 2016 IMF Global Financial Stability Report highlights, the involvement of international investors typically leads to improvements in corporate governance.

Conclusion

The decision by MSCI to add China A-shares is a positive development for investors, although it will take time for China A-shares to be fully included in the MSCI Emerging Markets Index. We believe that over time, China is likely to become a significant market within the Emerging Markets context provided it is able to enact the necessary reforms.

 

 

 

The commentaries contained herein are provided as a general source of information based on information available as of June 21, 2017 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in share and/or unit value and reinvestment of all dividends and/or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated.
The information contained in this commentary is designed to provide you with general information related to investment alternatives and strategies and is not intended to be comprehensive investment advice applicable to the circumstances of the individual. We strongly recommend you consult with a financial advisor prior to making any investment decisions. References to specific securities are presented to illustrate the application of our investment philosophy only and are not to be considered recommendations by AGF Investments. The specific securities identified and described herein do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable. This document is intended for advisors to support the assessment of investment suitability for investors. Investors are expected to consult their advisor to determine suitability for their investment objectives and portfolio.

 

About AGF Management Limited

Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.

For further information, please visit AGF.com.

© 2018 AGF Management Limited. All rights reserved.

Written by

Angela Rhoden

Angela Rhoden, CFA

Global Equity Analyst

AGF Investments Inc.

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