There are a lot of reasons to buy Chinese stocks.
For starters, in June, index provider MSCI announced that Chinese A shares (that is, shares listed on the local Shenzhen and Shanghai stock exchanges) will be included in MSCI indices. MSCI is the world’s most important index provider. Its decisions affect trillions of dollars of trading in the stock market. Fund managers and investors use its indices as a benchmark to build emerging-market portfolios. So global emerging market funds are adding more and more exposure to China.
And this is just one of the reasons we’re bullish on China. The country’s economy is also changing from manufacturing-focused to services-focused and its middle class is booming.
But there’s another reason you should buy Chinese shares, it could be the biggest long-term driver of all. And you’ve likely never heard of it.
I’m talking about Chinese investors themselves.
The truth behind Chinese investors
Individual Chinese investors took a lot of the blame for the 2015 speculative bubble – where stocks soared 68 percent from February to June and then crashed 49 percent over the next six months, on the back of Chinese investors essentially gambling.
And it’s true that Chinese investors account for the vast majority of the domestic equity market. Although it’s become a lot easier for foreigners to invest in China, according to some estimates, foreign investors account for less than 2 percent of total Chinese equity market ownership.
So you’d be forgiven for thinking that most Chinese own a large amount of Chinese shares.
But the reality is that compared to their peers in other countries, the Chinese people are enormously underinvested in stocks.
As you can see in the chart below, cash represents 72 percent of all household financial assets in China – that’s five times more than the U.S.’s 14 percent and two times more than the EU’s 36 percent. (All data excludes real estate assets.)
And relative to developed economies, stocks and funds only represent 9 percent of Chinese household assets. That’s a fifth of what U.S. households have. In short, compared to developed countries like the U.S., Singapore and those in the eurozone, China’s citizens are seriously underinvested in stocks and funds. So Chinese citizens have a lot of catching-up to do.
Why the Chinese are underinvested
Of course, the capital markets of developed countries are much more evolved than those of China. And individual investors in the U.S., Singapore and EU have a lot more capital to invest because they’re wealthier.
That explains part of the big cash-holdings discrepancy. But there’s more to it. For starters, there simply haven’t been that many avenues for people in China to invest. There is not a big mutual fund industry. Pension schemes and other insurance-linked investment vehicles are only just starting to take off. Capital controls restrict investors’ ability to buy foreign stocks or bonds. And the stock market’s reputation as a gambling den has dissuaded many less speculative investors from entering the market.
However, this is changing as the domestic equity market continues to mature – and over time, this will lead to more people in China investing more of their wealth in equities. For example, as recently as 2015, Chinese pension funds weren’t even allowed to buy stocks in the local equity market. But that’s changing, and pension funds have gradually been allowed to increase their asset allocations into domestic equities. Over time, this will provide the foundation for a steady flow of long-term investment into China’s stock markets.
Also, the regulatory infrastructure of China’s markets is steadily improving – which will in time give individual investors in China more faith in stock markets. China’s main securities regulatory body, the China Securities Regulatory Commission (CSRC), has pledged to crack down on speculative trading, especially in small-cap stocks. It’s also been active in reducing leverage in the financial system, which should help reduce the kind of wild swings that have characterised previous booms and busts.
On a related front, there is an increasing number of structures and vehicles available to Chinese investors to put money into the stock market. The easier it is to invest, the more people will do just that.
This doesn’t mean that the proportion of household wealth that’s invested in stock markets will increase to be close to developed markets anytime soon. But small changes in relative terms can result in big inflows in absolute terms. And over time, China’s domestic investors will become a critical foundation of the country’s stock markets. And that will help drive market growth.
How to buy China
One of our favourite ways to invest in China is through an exchange-traded fund like the KraneShares Bosera MSCI China A ETF (NYSEARCA:KBA). KBA tracks the MSCI China A International Index, which tracks the equity market performance of large-cap and mid-cap Chinese securities listed on the Shanghai and Shenzhen Stock Exchanges.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.