There are signs that European institutional investors find Chinese equities interesting. Finland’s Ilmarinen now separates China equity holdings (A and H-shares), in its reports, and Denmark’s AP Pension has boosted its China equity exposure to 5%, although it has excluded domestic property and banks.
There are still many reasons not to invest in Chinese equities, especially A-shares, which have performed abysmally with high volatility. There are also well-founded fears of a hard landing and market accessibility.
But QFII (qualified foreign institutional investor) quotas for A-shares have increased massively in recent years. The new Shanghai-Hong Kong Stock Connect programme will provide foreign investors with even greater access.
And a new category of RQFII ETFs (the R stands for renminbi) now allows for direct passive exposure to the A-shares market. Moody’s sees growth potential for Western asset managers here.
Chinese A-shares will doubtless find their way into global indices in coming years. This will address a key imbalance; A-shares are not currently part of the MSCI ACWI or emerging markets indices – and if they were, they would only account for 3% of the total ACWI market cap. China, on the other hand, accounts for more than 12% of the world’s GDP.
Western investors could add A-shares to an existing index portfolio as a diversifier, believes MSCI, as correlation of A-shares is low against other markets.
There is also low intra-market correlation between A-shares and the MSCI China index. One factor is low ‘GDP capture’, meaning there is a significant difference between the slice of GDP captured by A-shares and the MSCI China market.
A-shares are more concentrated in materials, industrials, consumer discretionary and healthcare stocks, whereas the MSCI China index is more heavily focused in energy, financials and IT.
Other off-putting factors include poor corporate governance and the herd behaviour of other investors. The A-shares market is dominated by retail ‘hot’ money chasing the latest investment fad or marketing story: 2012’s best performing fund ranked 541st in performance terms in 2013.
The associated high level of portfolio churn is one reason why Western asset managers have found it hard to make money from joint ventures in China, given the amount they must invest to always have the latest new product.
Greater market involvement by institutional investors would make the market much more attractive to foreign investors.
There are signs that Chinese enterprise annuity assets could grow to RMB1trn (€128bn) in the next three years or so, but this is a drop in the ocean compared with the size of the overall equity market, and there is a long way to go.