MSCI Indexes Take on the Red Dragon

June 1, 2018

The addition of Chinese A-shares allows foreign investors to trade large-cap mainland Chinese stocks for the first time.

  • Chinese A-share stocks will be added to a number of MSCI equity indexes in two phases this year: June 1 and September 3.
  • Although the inclusion of Chinese A-shares in the indexes presents significant growth and diversification opportunities, there are also risks involved in investing in China.

Last summer, MSCI announced its intention to add about 225 of China’s renminbi-denominated stocks (or Chinese A-shares) to the MSCI Emerging Markets Index, the MSCI ACWI Index and the MSCI China Index. The decision followed three consecutive years of the global index provider declining to make such a move. Now that another year has passed, MSCI will add Chinese A-shares in two phases. The first phase takes effect on June 1, 2018 and the second phase starts September 3, 2018.

How will this work?

Initially, only a fraction of all large-cap A-shares will be added to the indexes. Full inclusion (which would encompass both large- and mid-cap Chinese stocks) may happen down the road, and could bring China’s weight in the MSCI Emerging Market Index to more than 40%.

Full inclusion in the indexes would depend on several factors, primarily the resilience of Stock Connect—a program launched in November 2014 that links the two Chinese stock exchanges (Shanghai and Shenzhen) with the Hong Kong stock exchange. Before the program was initiated, only mainland Chinese investors (or qualified foreign institutional investors) were able to trade Chinese A-shares. Stock Connect allows international investors to do so as well—thereby increasing cross-border trading and reducing obstacles such as quota limits on purchases and extended delays for fund repatriation. Successful full inclusion also depends on whether China makes further progress on easing daily trading limits and improving corporate governance.

What does this mean for investors?

The addition of Chinese A-shares to MSCI indexes (which have historically held only foreign-listed Chinese stocks) gives foreign investors exposure to the fast-growing Chinese economy. Investing in A-shares can also provide another means of portfolio diversification, as they have a low correlation to other global market indexes.

MSCI’s inclusion also enhances China’s credibility as an emerging leader in the global equity universe—particularly as the Chinese A-share market includes many well-known large-cap companies, such as Bank of China, SAIC Motor and Tsingtao Brewery.

Of course, opportunity also brings risks. Many A-shares are issued by state-owned entities such as oil companies and banks. These have not been subject to much outside scrutiny, causing many to be tainted by fraud and corporate-governance issues. It’s now possible, however, that foreign investors could put the necessary pressure on China to improve these areas.

Chinese companies are well-known for enacting frequent and seemingly arbitrary trading suspensions, which could also present a problem for A-shares. MSCI said it intends to monitor trading, vowing to remove any company from the indexes that suspends trading for more than 50 days and restrict their re-inclusion for at least twelve months. Chinese regulators also indicated a commitment to strengthening laws concerning trading suspensions.

Legal Note

Important Information

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is intended for educational purposes only.

There are risks involved with investing, including loss of principal. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company.