MSCI will change the weight of China A shares in the MSCI Indexes by increasing the inclusion factor from 5 percent to 20 percent in three steps. Michelle Qi of Eastspring provides responses to key questions.
Michelle Qi, what does the MSCI decision mean for the China A-share market?
For the A-share market, the implication is that there will be an increasing allocation demand from global asset managers in the next few years. Following the three-step inclusion plan, the proforma weight of A-shares in MSCI EM index will be increased to 3.3 percent vs. 0.7 percent previously, leading to an estimated inflow of $70 billion to $80 billion this year, and an even larger inflow next year.
The presence of foreign institutional investors in the A-share market will be further strengthened. By the end of 2018, according to statistics from the People's Bank of China, foreign investors’ equity holdings stood at RMB1.15 trillion, or 6.7 percent of the A-share free-float cap. This scale is already close to the equity AUM of a domestic mutual fund, the mainstream local player in the A-share market.
«The positive trade talk is one of the drivers that contributed to the year-to-date market re-rating»
Accordingly, foreign investors in the onshore market will have stronger pricing power. The strong northbound inflows (RMB130 billion, 40 percent of total inflows last year) have been a key driver of the bull run in A-shares in the year-to-date.
Foreign investors’ investment thesis, research framework, and stock pitching preferences have already had and will continue to have a growing impact on the A-share market going forward.
What impact has the U.S.-China trade war had on Chinese markets?
The positive trade talk is one of the drivers that contributed to the year-to-date market re-rating. The potential tariff hike which may even develop into a full-blown trade war has been worrying A-share investors and weighing on market valuations throughout the past year.
«In the short-term, a straight drop in export growth may slightly drag Chinese GDP growth»
With the trade talks close to reaching a deal, the major external downside risks seem largely removed, leading to a recovery in market sentiment.
Which sectors do you believe will benefit the most from an improvement in U.S.-China relations?
An uplift will come across the board. We see the potential trade war having an impact on the Chinese economy mainly via two channels: In the short-term, a straight drop in export growth may slightly drag Chinese GDP growth.
Over the longer term, rising uncertainties due to U.S.-China tensions could result in slower global growth, which may further limit China’s corporate earnings and wage growth. The latter would have a more profound impact on the China economy than the former.
«Sectors with smaller export exposure especially to the U.S. could be hurt less than others»
Concerns over the trade war have been weighing on market sentiment and led to visible de-rating throughout 2018, as long-term uncertainties for business and economy rose. Therefore, we expect the A-share market to enjoy some re-rating across the board, should the U.S.-China relationship improve.
For investors looking to avoid the volatility of these trade negotiations, which sectors of the Chinese economy are least affected by the trade war? Why?
Intuitively, sectors with smaller export exposure especially to the U.S. (in other words, a higher reliance on domestic demand) could be hurt less than others. These sectors include healthcare, food & beverage, consumer services (media/tourism), real estate and so on.
«This may hurt market sentiment and weigh on valuations across the board»
However, if trade tensions intensify, it may hurt market sentiment and weigh on valuations across the board. Sector performances will then be determined by the details of domestic supportive policies, in credit and fiscal fronts.
Which other countries may benefit or lose out from an improvement in U.S.-China relations?
Should U.S.-China relations deteriorate, other manufacturing bases mainly exporters of the same products such as Mexico, Thailand, Germany, Canada, Japan, and Taiwan, will likely benefit from winning U.S. market share, and vice versa.
Michelle Qi, chief investment officer for China, has worked in the country for more than 20 years and helped to pioneer onshore investing. She is well-known for her long-term, sustainable and fundamentally driven approach to equity investing. This March, Eastspring is launching its first growth equity China A-share strategy that will be distributed by domestic securities firms and third-party wealth managers in China.
