A new way to invest in China: What including Chinese blue chips in the MSCI Emerging Market index means for investors

  • Some 230 Chinese domestic stocks, will be added to MSCI EM index from 1 June 
  • 'A shares' will also be added to the MSCI China and all country world benchmarks
  • Investing in China is not without risks - Jason Hollands of Tilney 

By MYRON JOBSON FOR THIS IS MONEY

Updated:

Investors have a new way to invest in China's domestic stocks and tap into the potential growth of the world's second-biggest economy.

Some 230 Chinese home-grown stocks, dubbed 'A shares' in the investing world, will be added to the MSCI's Emerging Market index in a two-step process between now, the start of June, and September.

This means trackers and ETFs that benchmark themselves against the emerging markets index will start to hold Chinese stock market listed firms, in addition to their existing sizeable exposure to Hong Kong listed Chinese firms, known as H shares.

The initial 5 per cent partial inclusion will boost China’s proportion of the MSCI Emerging Market index by only 0.8 per cent

The initial 5 per cent partial inclusion will boost China’s proportion of the MSCI Emerging Market index by only 0.8 per cent

A portion of these shares will also be added to the MSCI China and its global (MSCI ACWI) benchmarks. 

This means those who invest in funds that aim to track the performance of these indices will soon gain exposure to some of China's blue chip firms - like the state-owned car manufacturing firm SAIC Motor Corp and famed liquor maker Kweichow Moutai.

This change not only means that investors will have another way to invest some of their funds in China, but also the extra cash will flow into stocks as trackers and exchange traded funds adjust to create the holdings.

To put this into context, the total assets under management of funds that track the MSCI EM index alone is in excess of $1.6 trillion (£1.2 trillion), and analysts estimate about $22billion (£16.5billlion) will initially flow into Chinese stocks. 

Despite being the second largest economic powerhouse after the the US, most investors have very little direct exposure to Chinese companies in their investment portfolios.  

The state's governing regime has historically restricted overseas investment by implementing a number of laws restricting the amount of non-Chinese ownership in certain sectors including property, hotels and entertainment - and outright banning it in some.

The Hong Kong Stock Exchange and some US stock exchanges have traditionally been a gateway for foreign investors and even fund managers to invest in Chinese stocks.

What does it mean for investors?  

Investors won't be getting a major cross section of China's companies, however.

The number of mainland Chinese shares being added to the indices is just a slither of the more than 3,000 enterprises listed on China’s domestic exchanges in Shanghai and Shenzhen.

The initial 5 per cent partial inclusion will boost China’s proportion of the MSCI Emerging Market index by only 0.8 per cent, to 31.3 per cent. 

China A-shares will also form around between 4 and 5 per cent of the weight of MSCI China index and 0.15 per cent of the MSCI ACWI index.

The inclusion of China's A shares will have a very small effect on the make up of the MSCI Emerging Market index

The inclusion of China's A shares will have a very small effect on the make up of the MSCI Emerging Market index

The MSCI has stopped short of full inclusion of A shares in these indices over issues including capital mobility restrictions and uncertainties around taxes.

So the impact on passive funds that track either of these indices is minimal.

But if full inclusion were to happen, China stocks could comprise 42 per cent of the MSCI Emerging Markets Index - with A shares alone accounting for about 16 per cent of index weight. 

But investing in China is not for the faint hearted.

Some investors might remember the China stock market crash in 2015, where a third of the value of Chinese domestic stocks on the Shanghai Stock Exchange was lost within one month of the event.

The recent trade friction between the US and China, which recently saw the latter raise the tariff on steel and aluminium from the socialist state also adds to the sense of unease.

But many investment experts claim that there is a number of investment gems beyond the once-closed door to China's stock market.  

Jason Hollands, managing director of financial firm Tilney, said despite a marked deceleration in its growth rate in recent years, China's continues to outpace the developed world. 

He added: 'However, it is not without risk as the Chinese economic model has structural weaknesses including a rapid expansion of debt, overcapacity in certain sectors and its demographic make-up, often cited as a key strength, is set to deteriorate as the population ages and the workforce shrinks. 

'In the search for hidden Chinese gems, investors need to tread with care as governance standards are not akin to those found in developed markets, the Chinese authorities have no qualms about periodically interfering in the financial markets and there are many state-owned enterprises listed on Chinese exchanges where political imperatives might eclipse investor priorities.'

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