Skip to main content
MENU
Subscribe
  • Sign Up Free
  • LOGIN
  • Subscribe
  • Topics
    • Alternatives
    • Artificial Intelligence
    • Consultants
    • Defined Contribution
    • ESG
    • ETFs
    • Face to Face
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Regulation
    • SECURE 2.0
    • Special Reports
    • Washington
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Influential Women in Institutional Investing 2023
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • ESG Investing | Industry Brief
    • Innovation in ESG Investing
    • 2023 ESG Investing Conference
    • ESG Rated ETFs
    • Divestment Database
  • Defined Contribution
    • Latest DC News
    • The Plan Sponsor's Guide to Retirement Income
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • DC Plan Design: Improving Participant Outcomes
    • 2023 Defined Contribution East Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Research Center
    • The P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
  • Print
Breadcrumb
  1. Home
  2. INDUSTRY VOICES
February 07, 2019 12:00 AM

Commentary: Is 2019 the time for institutional investors to allocate to China A shares?

Douglas Eu
  • Tweet
  • Share
  • Share
  • Email
  • More

    Douglas Eu

    Pensions & Investments published a special report in January 2018 about the "big interest" in domestic Chinese equities, predicting that the handful of active A-share searches by U.S. defined benefit plans would soon turn into a wave as institutional investors proactively realigned portfolios to better reflect China's importance. Then, markets were hurt by trade tensions with Washington as well as concerns over Beijing's ongoing deleveraging efforts.

    With an eye on the longer term, however, a growing number of institutions have been engaged in discussions about allocating to China A shares listed in Shenzhen and Shanghai, a market that has a low correlation with major global equity markets and has the potential to add meaningful portfolio diversification. U.S. institutional investors had $652 million allocated to China A-shares strategies, including inflows of $33.6 million in the 12 months up to the end of September, according to eVestment. The increasing interest in Chinese equities follows MSCI's inclusion in June of China A shares to its MSCI Emerging Markets index for the first time. Based on MSCI guidance, China A-shares weighting of less than 1% will rise to 2.8% in August and to 3.4% in May 2020.

    Why should institutional investors get ahead of these shifts by boosting allocations to China generally, and to China A shares specifically? For starters, MSCI's weightings don't even come close to reflecting the importance of a domestic Chinese stock market that has a market cap comparable to Europe's and an economy that is forecast to be the world's largest by 2030. Allocating to China A shares is especially important because the companies these shares represent are more heavily exposed to China's ongoing shift from an export-driven economy into the so-called "new economy," with its higher-value-added sectors, such as hospitality, health-care equipment, industrial automation, new energy vehicles, biotech, software and smart manufacturing.

    Notwithstanding recent market turbulence, we view this opportunity to be as momentous as investing in emerging markets was a quarter century ago. What makes China A shares so attractive is, we believe, the combination of potential diversification benefits and Beijing's historical record of delivering on its growth and development plans. Diversification stems from the low correlation between China A shares and major equity indexes, from U.S. to Japanese and European stocks (Exhibit 1). Those low correlations may persist for two reasons. First, the China A-share market is still in its infancy, dominated by retail investors. Second, these firms derive about 90% of revenues locally, making them more sensitive to Beijing's domestic monetary and fiscal policies than the policies of the U.S. and other Western authorities.

    In addition, as noted earlier, China A shares offer exposure to significantly different sectors than are available in offshore China equities, such as H shares and American depository receipts, notably the faster-growing "new economy" sectors. Investors would find it impossible to gain the appropriate exposure to those sectors through traditional international equity and emerging market benchmarks (such as MSCI ACWI ex U.S. or MSCI EM) because those indexes have a significant mega- and large-cap bias. For example, more than half of the MSCI Emerging Markets index comprises just a dozen companies. And, as noted earlier, the MSCI Emerging Market index's China weighting will not be properly positioned to seize the opportunity for years.

    That said, China A shares do carry their own set of particular risk factors. These include the current dominance of retail investors, who account for more than 80% of daily turnover and can have a short-term focus. Also, earnings surprises are frequent, perhaps because local Chinese equity analysts are less experienced than their developed market counterparts. All this contributes to higher volatility, a high dispersion of returns and greater sector rotation compared to developed market indexes. Stock-trading suspensions are also relatively common (albeit declining) and the regulatory environment is still somewhat unpredictable. Still, on balance, such risks are typical of many developing markets and tend to diminish as the influence of institutional investors increases, as is expected to happen. As active investors, we believe that stock selection and on-the-ground research experience can help mitigate these risks and also exploit these inefficiencies for investors.

    Just as emerging market allocations became typical over the past 25 years, we believe allocations to onshore China will follow a similar path, starting with institutions adding a more significant allocation to China A shares as part of their current emerging markets allocation. How heavily emerging markets allocations should tilt toward onshore China will be different for every institution. However, our analysis suggests that a 10% to 20% direct allocation to China A shares (with funding coming from institutions' existing emerging markets portfolios) has the potential to modestly improve returns and significantly improve Sharpe ratios, as illustrated in Exhibit 2.

    While A shares had a rough ride in 2018, sentiment is often significantly more volatile than economic reality. For example, the price-to-book ratio for MSCI China A shares in early January was 1.54x, approaching the historical bottom of 1.47x. This suggests that valuations could be near an inflection point. On the three occasions since 2005 when the price-to-book ratio breached 1.6x, the index rose in the following 12 months, averaging an annual total return of 55%.

    In this light, we firmly believe that a direct allocation to China A shares with the intention of deliberately overweighting Chinese exposure against traditional emerging markets benchmarks is a viable option — arguably the only option — for institutions seeking to fully participate in the next stage of China's economic evolution, including the further development of its consumer sector.

    Douglas Eu is U.S. chief executive officer of Allianz Global Investors, based in New York. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.

    Related Articles
    Managers seeing signs of big interest with A shares
    FTSE Russell to give China A shares secondary emerging market status in June 20…
    A-shares success sets the stage for MSCI expansion
    Managers ride A-share wave to attract more investments
    Recommended for You
    Photo of Los Angeles Capital Management's Hal Reynolds and Sidharth Madan
    Commentary: What's next for high-quality growth stocks?
    Photo of Global Endowment Management's Matt Bank
    Commentary: Art of effective governance — helping investment committees avoid common pitfalls
    Photo of Schroders' Marina Severinovsky
    Commentary: Human capital management has quantifiable implications for investors
    Pension Risk Transfer: Derisking Trends and Considerations
    Sponsored Content: Pension Risk Transfer: Derisking Trends and Considerations
    Sponsored
    White Papers
    A Guide to Home Equity Investments: The Untapped Real Estate Asset Class
    Modernize your K-12 retirement plan with vendor consolidation
    Q4 2023 Credit Outlook: Price Is What You Pay, Value Is What You Get
    There's More Than One Way to Be a Climate Investor
    Exploring the Commercial Application of Artificial Intelligence
    Private Credit Insights: Every Problem Is an Opportunity in Disguise
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    October 23, 2023 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Custom Content
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2023. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Artificial Intelligence
      • Consultants
      • Defined Contribution
      • ESG
      • ETFs
      • Face to Face
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Regulation
      • SECURE 2.0
      • Special Reports
      • Washington
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Influential Women in Institutional Investing 2023
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • ESG Investing | Industry Brief
      • Innovation in ESG Investing
      • 2023 ESG Investing Conference
      • ESG Rated ETFs
      • Divestment Database
    • Defined Contribution
      • Latest DC News
      • The Plan Sponsor's Guide to Retirement Income
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • DC Plan Design: Improving Participant Outcomes
      • 2023 Defined Contribution East Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Research Center
      • The P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
    • Print