Access to China A-shares, one of the largest equity markets, is becoming easier for overseas investors. Daniel Ben-Ami reports
When foreign newspapers cover the Chinese markets they often make what could politely be called a schoolboy error. To illustrate a day of market falls they often use a photo of a trading screen with many prices shown in red. Apparently they do not realise that the colour signifies the opposite in China to what it means in the West.
Jian Shi Cortesi, an Asian fund manager at GAM, explains: “In China when a stock goes up it’s shown in red. When a stock goes down it’s shown in green.” So a sea of red on a Chinese trading screen is something to be welcomed.
Of course every market, even the smallest, has its idiosyncrasies. But with China’s huge domestic stockmarket increasingly opening up to outsiders it is one with which foreign investors will inevitably become more familiar. It is one of the world’s largest by market capitalisation and about 3,000 companies are listed. In particular, access to China A-shares – denominated in renminbi and traded on the Shanghai or Shenzen exchanges – is becoming easier.
Although liberalisation towards overseas investment started as far back as 2003 the process has recently taken significant steps forward. FTSE Russell moved first with the announcement in May that it would allow an initial 5% weighting for A-shares in its FTSE Emerging inclusion series. Over the longer term, as the shares became fully available to international investors, the index provider said it would increase the weighting to 32%. MSCI followed with a more hesitant move saying it intends to include China A-shares in its global indices once some remaining issues are resolved. Such moves pave the way for overseas index funds to sharply increase their holdings in domestic Chinese stocks.
Vanguard, one of the world’s largest fund groups, made its move even before MSCI’s tentative step forward. The US group has already announced plans to include A-shares in its Emerging Markets Stock Index fund and its VWO exchange traded fund. In an official statement the group’s chief executive, Bill McNabb, was quoted as saying that the move would benefit its investors through “more diversification, deeper emerging markets exposure, and greater access to the growth potential of Chinese equities”.
The desire of the Chinese authorities to facilitate foreign investment into domestic markets has helped create the impetus for such moves. The Shanghai-Hong Kong Stock Connect scheme, launched in November 2014, allows overseas investors to trade eligible shares on the Shanghai Stock Exchange through Hong Kong brokers. A similar arrangement with the Shenzen market is likely to be announced soon.
Cortesi says it will take time for compliance departments and local fund regulators to fully accept the Stock Connect scheme. Nevertheless, she expects that over time the older methods for overseas investors to get access to the market up to a maximum quota are likely to become less important. These include the Qualified Foreign Institutional Investor (QFII) scheme and the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme.
In any case, overseas investment into the Chinese equity markets is likely to increase sharply, as it is in the interests of both China and international investors.
At a glance
• China’s huge A-shares market is increasingly open to foreign investors.
• Index providers are slowly moving to include A-shares in their indices.
• Opinions are divided on whether the market is overvalued at current levels.
• The changing nature of the Chinese economy is likely to benefit some sectors and hit others.
From an official Chinese perspective, the opening up of domestic markets is part of a broader project to get the renminbi to play a larger international role. Marcus Shadbolt, managing partner at Vermilion, a specialist investment advisory firm with an extensive Chinese business, says: “China wants to move away from having lots of trading transactions still settled in US dollars. This is all part of getting the renminbi accepted as a settlement and reserve currency.”
Victoria Mio, the lead manager of Chinese equities at Robeco, says there are three main attractions for overseas investors. “From a global asset allocation perspective A-shares have low correlations with other markets,” she says. For that reason they provide a diversification opportunity. In addition, she says the currency is likely to remain strong as China retains a current-account surplus. As a result, European investors are likely to benefit from a currency uplift to their investments. Lastly, the Chinese markets seem to be a in a sustained bull market.
That still leaves open whether now is a good time to invest. The sharp rise in China’s domestic markets over the past year has led some to raise fears of a bubble.
Cortesi sees the recent rises as mainly a reaction to a bear market that lasted several years. “In certain small pockets there is a bubble but overall the whole A-share market is not in a bubble because there was a six-year bear market,” she says. She points out that the price-earnings ratio for the market as a whole is close to its historical average.
In her view, this may not be the best time to buy the index but there are selected opportunities worth taking. “In the blue chip space you can find still find some well-established companies trading at reasonable valuations compared to their growth prospects,” she says.
Shadbolt is more sceptical. In his view, the market is clearly overvalued. “I don’t think it’s recovery to fair value, I think it overshot that a while ago,” he says.
Whatever the truth about current market levels there is broad agreement that the economic shifts China is undergoing will benefit some sectors and hit others. As the Chinese economy becomes more mature there is less emphasis on cheap manufacturing and more on domestic consumption. Old economy sectors, such as those focused on exports and domestic infrastructure, are likely to do less well. New economy sectors, including those focused on domestic consumption, are likely to do better. Government policy to bolster clean energy and tighten environmental protection is also likely to create some winners.
Mio identifies additional factors which should help bolster markets, and some sectors in particular, over the long term. The reform of state-owned enterprises, many of which are in old economy sectors, should provide a beneficial restructuring.
She also points to the government’s ‘one belt one road’ initiative. The ‘one belt’ refers to a new silk road economic belt which will link China with Europe through central and western Asia. The one road refers to the twenty-first century maritime silk road which represents a sea route through the Strait of Malacca to India, the Middle East and east Africa. Through this initiative, China will use its financial capital to help fund regional infrastructure to promote trade and improve relations with the Association of South East Asian Nations, central Asia and Europe.
Finally, there is China’s official Internet Plus strategy. According to Xinhua, the official news agency: “The plan aims to integrate mobile internet, cloud computing, big data and the internet of things with modern manufacturing, to encourage the healthy development of e-commerce, industrial networks, and internet banking, and to help internet companies increase international presence.”
Whatever the success of such initiatives, and whether or not current valuations are justified, it is hard to resist the conclusion that overseas investment into A-shares is likely to soar. This simply seems to be a matter of the world catching up with the reality of China gaining more substantial weight as a financial power.