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Investors urge rigorous research as China shares win MSCI inclusion

China-Shanghai-Modern-Asia-700x450.jpgChina shares are to be added to MSCI indices following a long debate with institutional investors and regulators on their inclusion.

From May 2018 China’s onshore A shares will be included in the flagship MSCI Emerging Markets index as well as the MSCI ACWI index, following a consultation launched by MSCI in March 2014 to open up the world’s second largest market to foreign investors.

MSCI plans to add 222 China A Large Cap stocks, which will account for around 0.73 per cent of the MSCI Emerging Markets index. This is higher than the 169 stocks originally proposed, as all large-cap shares that are not excluded due to trading suspension will be included on the back of investor demand.

The index provider will apply a 5 per cent inclusion factor to the constituent shares based on the estimated emerging markets allocation of the main global asset managers, although MSCI said this could potentially increase, while mid cap shares may also be included if warranted.

Remy Briand, MSCI managing director and chairman of the MSCI index policy committee, says that when investors “gain further experience in the market” there will be “a higher representation of China A shares in the MSCI Emerging Markets index”.

“International investors have embraced the positive changes in the accessibility of the China A shares market over the last few years and now all conditions are set for MSCI to proceed with the first step of the inclusion,” Briand says.

Investors welcomed the widely anticipated move by MSCI, but say thorough research will be vital.

Dale Nicholls, portfolio manager of Fidelity China Special Situations, says the announcement “ensures foreign investors can no longer ignore China’s onshore market”.

“The breadth and depth of China’s onshore market is huge, but still relatively under-researched, which means there are many interesting stock picking opportunities. I would expect that over time the onshore A-share market grows in importance not just in Asia, but globally too.”

Julie Dickson, investment director at Capital Group, warns of the need for “rigorous, fundamental analysis” in the “less well researched market”.

“Employing a passive investment approach that will simply increase exposure if the index representation grows can lead to unintended investment risks,” she says.

Nick Beecroft, Asian equity portfolio specialist at T. Rowe Price, says the initial impact on global indices will be “extremely modest”, but could have bigger implications long term.

“Over the long term, assuming further liberalisation and regulatory reform of the mainland stock markets, the depth of China’s A-share market could mean China gains substantial weight within those broader indices. As this market opens further, global investors will need to dedicate increased time to understanding the unique attributes of this market, and the deep pockets of opportunity that it offers.”

Gary Greenberg, head of emerging markets at Hermes Investment Management, remains wary of corporate governance issues in China.

“In our experience, many Chinese A-share managements have yet to fully grasp the duties imposed by a listing, not to mention inclusion in a global index. We continue to encounter managements of large A-share companies who have yet to appoint an investor relations officer and who see no reason for senior management to meet shareholders.

“Governance is often a challenge, as management may owe primary allegiance to municipal, provincial or national administrations. Capital discipline, avoiding low-return projects, can run into conflict with the requirements of a related city or province for new infrastructure. The ability to communicate with foreign investors, even in companies with worldwide operations, tends to be less than world class. For businesses with top line revenues that can top $15bn, this should have been fixed by now.”

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