Why You Should Own China's A Shares Right Now

Summary

• We're starting to see money flow into China's A shares.
• But it's just getting started.
• And it's getting easier and easier to invest.

Last June, China’s stock markets took a global step forward.

Global market index provider MSCI announced that it would start including China’s A share market (shares traded on the Shanghai and Shenzhen exchanges) into its MSCI Emerging Markets Index.

As we pointed out at the time, this is a big deal.

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 it as a benchmark to build emerging-market portfolios. So when MSCI adds or removes stocks or countries from its index, a lot of money eventually follows it.

So one of the long-term implications of the news is that there will be a slow wave of money flowing into China’s A share market.

We’re starting to see that now. But there’s plenty more to come.

A trickle, so far…

Despite all the enthusiasm in the financial media surrounding the news, it’s important to remember that the A shares that MSCI is including in its MSCI Emerging Markets Index thus far only represent a tiny fraction of that index.

MSCI adjusts its inclusion in the index to reflect not just market capitalisation of stocks, but free float available to investors, as well as foreign ownership limits on shares in companies and access to market for investors. (China is far from an open market when it comes to access to stocks and ownership conditions.)

In total, Chinese shares will represent about 29.28 percent of this index by August 2018. But 28.55 percent is represented by stocks of Chinese companies trading on exchanges outside of China itself. Only about 0.73 percent of the total index will be Chinese A shares.

Still, this is the start – and the mere act of including A shares has encouraged a rush of funds to be launched to track a variety of China stock indices. As of January, one fund tracking the MSCI China A International Index (an index recently launched to track the progressive partial inclusion of A shares in the MSCI Emerging Market Index) has been launched, and there are about two dozen waiting approval. So we can expect a surge in exchange traded funds coming to market in the next year or so tracking various China indices.

But the move into A shares is just getting started.

It’s getting easier to invest in A shares

For years, foreign investors have had minimal access to China’s markets – despite China’s stock markets being the second- or third-largest stock market on the planet.

That’s because it has been difficult for foreign investors to buy and sell the shares of Chinese companies that are listed in China. There have been various programmes that have allowed qualified foreign investors to directly buy/sell Chinese stocks, but only under heavily regulated and controlled conditions. And it’s been almost impossible for smaller funds and individuals to buy Chinese shares.

That’s slowly changing, though.

In 2014, China created the “Stock Connect” programme, which is a collaboration between the Hong Kong, Shanghai and Shenzhen exchanges. It allows foreigners to trade certain Chinese stocks listed on the Shanghai and Shenzhen exchanges and for Chinese investors to trade shares in Hong Kong. The programme includes more than 2,000 China A shares that can be traded by investors through the Hong Kong Exchange. And in November, more than US$1 trillion worth of stocks had been traded under this scheme.

I fully expect China’s stock market to gradually open even more, giving foreigners increasing access to the markets, and also allowing Chinese domestic investors increasing access to outside markets.

This is being reflected in the development of various indices tracking China’s markets and the array of investment products available.

And I expect we’ll see MSCI include further A shares in its index down the line. There will also likely be some more ETFs launched that will follow A shares. After all, in time investors will be able to directly capture the growing numbers of local Chinese listed stocks that are now being made accessible to foreign investors via the Stock Connect schemes.

In short, China’s equity markets are getting harder to ignore. Some of the easiest ways to invest in the A shares market are below.

Analyst’s 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.