Morgan Stanley Capital International's, or MSCI, has announced it will add China A-shares into its benchmark indices. In anticipation of the changes, investors will have an opportunity to jump in and ride the wave through China A-shares-specific exchange traded funds.
In the recent 2017 market classification review , MSCI announced plans to add 222 China A Large Cap stocks to its benchmark MSCI Emerging Markets Index. It will initially add about 0.73% of the weight of the EM Index during its May 2018 Semi-Annual Index review and gradually increase the exposure to China A-shares to minimize the effects of the buying spree on market prices.
This can potentially be a huge deal for Chinese markets as MSCI is the world's biggest stock index provider, with the MSCI Emerging Market Index currently having about $1.6 trillion tracking it. Consequently, any changes to the benchmark will create sizeable waves in global markets as big and small investors scramble to make changes to their portfolios.
Currently, the benchmark MSCI EM Index includes Hong Kong-listed or NYSE-listed Chinese company stocks to help investors gain indirect exposure to Chinese companies, which leaves many woefully underallocated to Chinese markets - about less than 2% of domestic Chinese shares and bonds are held by foreigners.
"Investors should have A-shares in portfolios, especially emerging market investors," Luke Oliver, Head of U.S. ETF Capital Markets for Deutsche X-trackers US, told ETF Trends in a call. "MSCI validates this thesis with inclusion of A-shares. If you're in EM now, you're not really in it without China A-shares."
Looking beyond the potential benefits of increased demand for China A-shares ahead of the major index changes, Chinese markets exhibit strong macro fundamentals. Robert Bush, ETF Strategist for Deutsche Asset Management, said in a note Deutsche Bank forecasts the economy to grow 6.3% this year and the next in its ongoing stellar growth that defined the economy for much of the last few decades.
The country itself is also seeing major changes that could help the economy move toward more sustainable and steady economic growth. For instance, Oliver pointed out that GDP services for the first time recently broke above 50% or domestic consumption is finally making a major role in economic growth as compared to yesteryear when China followed a more export-oriented business model. Furthermore, consumer price inflation shows a stable reading of 2% to 3%, unemployment stands at around 4% and Deutsche expects fiscal deficit to shrink to 3.2% in 2018 from 3.4% this year.
"It seems like China has plenty of ammunition to weather any future economic storms," Bush said.
China A-shares may also help better diversify an equity investment portfolio as the Chinese domestic markets exhibit low correlation to U.S. equities.
"Despite having a considerably higher volatility, the low correlation of Chinese and American stocks resulted in a portfolio with higher return and lower risk. In our opinion, this evidence alone makes China a very compelling market to consider," Bush added.
Investors who are interested in domestic China A-shares can access Chinese markets directly through options like the VanEck Vectors ChinaAMC SME-ChiNext ETF (NYSEArca: CNXT ) , VanEck Vectors ChinaAMC CSI 300 ETF (NYSEArca: PEK ) , iShares MSCI China A ETF (BATS: CNYA) and db X-trackers Harvest CSI 300 China A-Shares Fund (NYSEArca: ASHR ) .
PEK tracks the CSI 300 Index, which includes the 300 largest and most liquid stocks in the China A-shares market. CNXT includes the 100 largest China A-shares stocks listed on the Small and Medium Enterprise Board and the ChiNext Board of the Shenzhen Stock Exchange. CNYA tracks an MSCI index composed of Chinese equities listed on the Shanghai and Shenzhen Stock Exchanges. ASHR also tracks A-shares taken from the CSI 300 Index.
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This article was provided by our partner Tom Lydon of etftrends.com.