China’s Growing Sway in Global Equities

Published on11 MAR 2019

The article below is from our BRIEFINGS newsletter of 11 March 2019

Chinese stock markets are getting a boost from the decision by global index provider MSCI to quadruple the weighting of mainland China stocks, known as A-shares, in its benchmarks. We sat down with Kinger Lau, Chief China Strategist of Goldman Sachs Research, and Christina Ma, Head of Greater China Equities of Goldman Sachs Securities, who explained the implications for investors. 

Kinger, this is an issue that you've followed closely for years, and that you and Christina discussed with us last year. What do you make of MSCI's latest announcement to increase the inclusion factor of Chinese large-cap stocks to 20% from the current 5% by November?

Kinger Lau: As we've said before, we believe MSCI's move will draw more foreign institutional capital into the Chinese markets since the global funds tracking the MSCI indices will have to comply with their mandates. With the latest announcement, we estimate that at least $70 billion could flow into China A shares, with flows likely skewed toward the consumer and healthcare sectors. Those flows will, in turn, further lift valuations for A shares which have already rallied this year. It's important to note, however, that the actual flows into Chinese mainland shares are likely to be much higher. First, of the 350 largest emerging market mutual funds, only about half have some exposure to China A -- meaning that the rest have no exposure at all. But when A-shares jump to 3.3% of the MSCI benchmark later this year, from about 80 basis points currently, asset managers will have to follow suit. Second, our flow estimates do not take into account the potential inflows from non-benchmark-oriented mandates, which are significantly larger than mutual funds and ETFs in terms of AUM. Lastly, the upside surprise of the announcement was really the breadth of the inclusion universe -- including a move to accelerate the addition of mid-cap companies -- compared to what MSCI had proposed last September. This certainly expands the investable universe for global investors and incentivizes incremental allocation to China A beyond the top 20 to 30 "foreign favorites."

How will asset managers implement the proposed changes?

KL: Recent investor feedback suggests to us that some asset managers may have to invest in China A-shares through substitutes because of various regulatory, accessibility, legal and other restrictions. As a result, while MSCI is making it easier to invest in China, some investors are being forced to go with a "Plan B" to invest in China A-proxies. Many of these indirect vehicles -- dual-listed shares in Hong Kong, ADRs or offshore-listed China A ETFs -- are potential alternatives, but the sensitivity and correlation to China-A varies. From our analysis, we think insurers and brokerage stocks have the highest correlation to China A-shares.

Christina, this appears to be another step toward putting China on the global equity investing stage. What is the significance of MSCI's latest move for investors?

Christina Ma: While the notional value of the A-shares that will make up the MSCI indices is relatively small, the strategic and business impacts are significant as China continues to open up its capital markets. A number of regulatory reforms, such as last year's announcement allowing foreign firms to ultimately own 100% of their onshore joint ventures, are strong signals that the market is further opening up for foreign investors. Additional initiatives announced this year, such as the launch of a new Tech board -- set to launch in the coming months -- that will make it easier for companies focused on technology and innovation to list domestically as opposed to seeking liquidity abroad. While it's still early days, China is clearly moving toward opening up and broadening the scope of its capital markets. Overall, these are all part of broader reform measures to improve investor sentiment, promote China's fast-growing new economy sectors and attract more institutional investors onshore. 

How are geopolitical tensions affecting the path of reforms and client sentiment?

CM: Concerns over trade tensions between China and the US clearly weighed on clients toward the end of last year. But now that we're past the March 1 trade talks deadline and it seems like talks are proceeding, sentiment has improved. Clients understand that there might be some geopolitical or market risks in the short term, but that doesn't affect their long-term planning strategies. For our part, we're having more conversations with clients looking at China's long-term story and are building our businesses to ensure that we have the necessary infrastructure in place to work with clients.