China A-Shares: Worth The Wait?

by: Zacks Funds

MSCI decided last week not to include China A-shares on the MSCI Emerging Markets Index. The index compiler has decided to defer this decision until it sorts out outstanding issues with the country's securities regulator. In the same week, data from EPFR Global showed that $9.3 billion was pulled out of emerging market funds and most was from China. This was the biggest weekly outflow in 15 years.

Now, the Institute of International Finance (IIF) has warned that emerging markets may face more exodus as the US central bank approaches a "lift-off".

Before we focus on relevant mutual funds, let's look into some other details.

China A-shares

The decision to not include China A-shares at least now comes as a temporary setback to China's efforts to raise the standing of mainland capital markets and internationalize the yuan. China A-shares are listed in Shanghai and Shenzhen. These are denominated in yuan.

However, this should be good news for other countries whose stocks are listed on the index. Emerging market investment instruments would thus gain, as this non inclusion will help keep the money flow to them.

Outstanding Issues

According to MSCI's website, it will only include mainland shares after it resolves certain outstanding issues. The company said it will form a working group with China Securities Regulatory Commission, the country's securities regulator for this purpose.

Among the issues to be resolved were capital mobility, beneficial ownership details and restrictions on investment. The measured approach adopted by MSCI on A-shares has been praised by several market watchers and analysts.

Restrictions on Investment

Foreign investors still have to conform to restrictions on investments per the conditions laid down by authorities regarding the Shanghai-Hong Kong exchange link. This link which commenced in November provides investors with a brokerage account in Hong Kong with access to stocks listed on the mainland.

However, foreign investors can purchase a maximum of net 13 billion yuan ($2.1 billion) of such shares per day. They are also subject to an aggregate quota of 300 billion yuan.

MSCI has said that it will collaborate with Chinese authorities to ensure that such quotas correspond to the amount of assets under management of investors. Close coordination with China's authorities will hasten this process, the index provider said. However, the announcement of the inclusion of A-shares and the implementation will be separated by a 12-month period.

More Exodus

On the other hand, IIF believes there may be more outflows from emerging markets. Jean-Charles Sambor, Asia Pacific director at the IIF, said: "We think the weakest emerging markets are likely to continue to suffer from pretty large outflows both on the debt side and equity side."

However, the outflows may be prominent for weaker economies having weak macro fundamentals. These economies mostly pertain to the Middle East and Latin America.

Also, of the $9.3 billion outflows from emerging market funds, China equity funds accounted for $7.1 billion of the outflows. This probably hints that not all emerging market economies may be in a spot of bother.

Short Term Setback

Most analysts believe that this setback for A-shares is only short term in nature. Even though, the majority of market participants would have liked the inclusion to come much sooner, MSCI has sent out a clear signal. Fund managers would have to factor in the possibility of such a change taking place before 2016.

In fact, China has already dealt with major concerns on market accessibility raised after last year's MSCI review. Firstly, an announcement was made in November last year that shares bought via the exchange link will be temporarily exempted from capital gains taxes. Authorities have also reduced restrictions on having more than one broker. Additionally, they have also initiated a trial run of same day trading of select stocks.

Funds in Focus

If the setback is a temporary phenomenon, certain emerging market and pacific funds would continue to be great investments. The recent dismal performance should not be a cause for concern. Top-ranked funds with great fundamentals should be good additions to portfolios. In any case, the non-inclusion of China A-shares means money would stay with the other emerging market countries' investment instruments.

The following funds carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy) as we expect the funds to outperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

They also have encouraging year-to-date and 3 and 5-year annualized returns. They carry no sales load and the minimum initial investment for these funds is within $5000.

Matthews Korea Fund (MUTF:MAKOX) seeks capital growth over the long-term. MAKOX invests a large chunk of its assets in common and preferred stocks of South Korea companies. The fund focuses on mid to large cap firms, but is not restricted to them.

MAKOX currently carries a Zacks Mutual Fund Rank #1. MAKOX boasts year-to-date return of 12% while the 3 and 5 year annualized gains stand at 14.7% and 12.4%.

Wells Fargo Advantage Asia Pacific Fund (MUTF:SASPX) seeks capital growth over the long run. SASPX allocates a lion's share of its assets in equities of companies located in Asia Pacific Basin. SASPX emphasizes on factors including earnings growth, financial condition and management efficiency for selecting companies. SASPX may also invest in participation notes.

SASPX carries a Zacks Mutual Fund Rank #2. SASPX boasts year-to-date return of 9.3% while the 3 and 5 year annualized gains stand at 15% and 10.4%.

Fidelity® Emerging Asia Fund (MUTF:FSEAX) invests heavily in companies from emerging economies in Asia. FSEAX may also invest in other securities that are related to emerging markets of Asian countries. FSEAX focuses on acquiring common stocks of companies depending on factors such as economic conditions and financial strength.

FSEAX carries a Zacks Mutual Fund Rank #2. FSEAX boasts year-to-date return of 7.2% while the 3 and 5 year annualized gains stand at 12% and 8.9%.

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