Index of the Future
At present, the main equity indices do not provide an adequate reflection of China’s economic standing in the world. This is largely because, in the past, foreign investors could only gain access to the market for Chinese domestic stocks, or A-shares, subject to major restrictions.
The forthcoming inclusion of Chinese A-shares in the MSCI Emerging Markets Index means that China will be assigned a greater weight in this benchmark. This is reason enough in itself to look at index investments on Chinese equities.
Foreign investors generally find it harder to access emerging markets such as China than their developed counterparts. Ownership limits and capital controls certainly make it more difficult for foreigners to obtain access. Reduced competition among providers of trading platforms and stock market services as well as idiosyncrasies in the market structures pose an additional challenge.
In the past, these barriers to market entry have meant that the geographical distribution of global market capitalization in the indices has failed to properly reflect the corresponding economic output, or gross domestic product (GDP). Relative to the country’s economic output, the US is over-represented in market-weighted indices. In contrast, the People’s Republic of China is under-represented due to the restrictions imposed on foreign investors’ access to A-shares.
Fresh focus on Chinese domestic stocks
The good news is that the Chinese market is becoming more and more open to foreign investors, including index-oriented investors. Although Chinese equities are already included in the main MSCI indices, this is only true of stocks that are traded in HKD, USD and SGD. The current MSCI China Index does not include any A-shares and therefore only covers some 60% of the investment opportunities in China at present. As a result, the benchmark offers no coverage of a significant chunk of the market. Nevertheless, this year will see around 230 A-shares being admitted to the MSCI Emerging Markets Index. However, the index will initially only include 5% of A-shares’ market capitalization.
For investors wishing to participate in the Chinese equity market without the need for labor-intensive stock selection, time-consuming monitoring and elevated cluster risks, an index product is the most suitable choice. An index such as the MSCI China All Shares, which already replicates the full market capitalization of the A-shares in the MSCI China benchmark, should be seriously considered. The MSCI China All Shares Index benefits from very broad diversification across stocks and sectors, giving investors the opportunity to participate in the full spectrum of the Middle Kingdom’s investment opportunities via a single instrument.
The MSCI China All Shares Index in brief
The MSCI China All Shares Index captures large and mid-cap representation across Chinese A-shares, B-shares, H-shares, Red-chips, P-chips and foreign listings (e.g. ADRs). The index aims to reflect the full opportunity set of Chinese share classes listed in Hong Kong, Shanghai, Shenzhen and outside of China. It is based on the concept of the integrated MSCI China equity universe but with Chinese A-shares included. The sector weighting of the MSCI China All Shares Index is also more diversified as compared with the MSCI China Index, for example.
The MSCI China All Shares Index is constructed by applying the MSCI Global Investable Market Indexes (GIMI) methodology, the same framework used for the MSCI Emerging Market Index.
By targeting a full investable market representation instead of a fixed number of securities, the MSCI China All Shares Index is designed to dynamically reflect the evolution of China’s opportunity set.
For the past five years ending January 2018, the MSCI China All Shares Index has produced a higher relative return than the China A International Index, for example.