On June 20th, index provider MSCI announced big news. They finally decided to include mainland Chinese stocks (known as A-Shares) to their indexes. The world’s second largest economy will now get a stage in a huge index. The MSCI Emerging Markets Index alone is tracked globally by an estimated $1.5 trillion of assets. By including A-shares, this massive amount of dollars would need to allocate, or at the very least, consider allocating portions to the A-share market. Sounds like demand to me!
However, we have to go beyond the news to truly understand the short-term and long-term implications of this. First, the short-term:
- This wasn’t a secret – MSCI had been reviewing inclusion for years and working with Chinese authorities to get changes they’d like to see made before the addition to the index. This was well telegraphed and continuously covered in news, research, and other mediums. Buying China now because of this inclusion decision would be rear view decision making.
- It’s not that big – Sure, the A-shares are now going to be in the market index, but it’s only a 5% inclusion factor impacting just 222 stocks to start. On net, this increases exposure to China (which already had large exposure through Hong Kong) in the index by less than a percent.
On a longer-term basis, China has been working to become more of a global economic superpower and we have to think about the following:
- A reserve currency – China pushed in years past to get into a basket of currencies the International Monetary Fund called reserve currencies. This happened in 2015. This not only has status to it, but gives countries across the world reason they may want to hold Chinese currency.
- Opening up of stock markets – Like the currency inclusion, China has been working hard to give enough, but not too much, in order to get stock index inclusion. By making this jump, more capital potentially could flow to companies listed in the local market to benefit their economy.
- Performance has been flat and wild – If you look at the 5 year performance chart below, the A-share index has not been the smoothest ride. There was a period of flat returns followed by an incredible boom, an incredible bust, and then another relatively flat ride. Future performance is by no means guaranteed to be any different because of this inclusion decision.
- More needs to be done –While China has gotten better in terms of market rules, it still remains uncertain with regards to investor taxation, voting rights, restriction of capital flows, and rules governing trading suspensions of securities. For a larger slice of the index pie there is work to do.
- Investing could change…later – If and when a full A-share inclusion happens, MSCI estimates that China would represent over 40% of the Emerging Markets Index. That would lead to future decisions about whether the index itself is diversified within emerging markets enough or should investors instead break up the market index and invest in various countries/regions on a standalone basis. This is unlikely to happen rapidly.
While China’s A-share inclusion is a big headline, in the short-term it has very little effect and an immaterial impact on your portfolio. Over time, China is faced with its continued tightrope walk between communism and democracy, its transition from a manufacturing economy to service, and its population issues which may make the long-term picture of a climb to full market inclusion fuzzy at best.
MSCI Emerging Markets USD (EM)
The MSCI Emerging Markets IndexSM is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
Shanghai A-Share Stock Price Index (A Share Index)
The Shanghai A-Share Stock Price Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares listed on the Shanghai Stock Exchange that are restricted to local investors and qualified institutional foreign investors. The index was developed with a base value of 100 on December 19, 1990.