MSCI index weighting boost opens door for overseas influx; greater stability also predicted
Institutional allocations to China's A shares are set to surge this year in tandem with their rising weight in global benchmark indexes, providing an ironic boost for the market's latest retail-powered bull run.
Analysts say MSCI Inc.'s recent decision to lift the weight of A shares to 3.3% of its emerging markets index by November from 0.7% at present should prompt net inflows from overseas investors of between $65 billion and $85 billion in 2019.
Chia Chin Ping, MSCI's Hong Kong-based head of research for Asia-Pacific, said his firm's Feb. 28 decision to boost the portion of China's A-shares markets included in MSCI's index this year to 20% from 5% should draw $80 billion in net inflows — 15% passive and the rest active.
With FTSE Russell likewise adding A shares to its emerging markets indexes for the first time in June, Morgan Stanley (MS) at the end of January predicted record foreign A-shares purchases of between $70 billion and $125 billion this year, including $25 billion in passive flows and another $25 billion in active flows from asset owners instructing their emerging markets managers to match the higher A-shares weights in MSCI and FTSE indexes. The remaining $20 billion to $75 billion would come from additional active allocations.
"The interest we're seeing is rising pretty rapidly," with RFPs from some institutional investors and an extraordinary number of conversations with prospective clients around the world, said Donald Amstad, Singapore-based chief operating office and head of investment specialists for Asia-Pacific with Aberdeen Standard Investments.
With mainland stocks poised to account for roughly 15% of MSCI's emerging markets index as the remaining 80% of China's markets is included over the coming five to 10 years, more and more offshore asset owners are looking to discuss how to position their portfolios strategically, said Wong Kok Hoi, founder and group chief investment officer with Singapore-based APS Asset Management Pte. Ltd., a Chinese equity boutique with $2.6 billion in assets under management as of Dec. 31. Many are considering hiring dedicated China managers as opposed to relying on their emerging markets managers to give them exposure to that market, he said.
The number of conversations continues to dwarf the number of RFPs but the quantum leap in the ranks of asset owners reviewing their China options now points to a pickup in mandates as well, investment consulting veterans predict.
In a March report, "The Case for Dedicated China Exposure," Boston-based Cambridge Associates LLC said with mainland stocks and bonds both set to become material components of global benchmarks this year institutional investors should be methodically sketching out their approach to China.
Aaron Costello, Cambridge Associates' Singapore-based head of Asia-Pacific, said in an interview there's a compelling case to be made for making dedicated allocations to China, whether in public or private markets, but it's up to each institutional investor to decide "how much China" they should have in their portfolios, and whether to use long-only vehicles or hedge funds, all-China strategies including Chinese companies listed in Hong Kong or New York, or dedicated A-shares strategies.
For A shares, Cambridge's report said the case for dedicated allocations includes the diversification benefits of exposure to a market not highly correlated with other developed or emerging stock markets; the market inefficiencies active managers have proven adept at exploiting; and valuations which remain attractive even after a strong new year's rally.
Some of those factors are more transient than others, which could leave institutional investors that stay on the sidelines giving up an "early-mover advantage," Mr. Costello said.
The Cambridge report said while each institutional investor will reach its own conclusions on how much China to have in its portfolio, having 5% to 10% dedicated to Chinese stocks, bonds and private markets is "reasonable."
For now, asset gathering for A-shares managers remains at a very early stage, analysts say.
"There's a lot more discussion ... but limited new allocations," noted James Jackson, a senior consultant and equity specialist with Aon Hewitt Investment Consulting's global investment manager research team in London. But the number and extent of those conversations is accelerating and in anticipation of search activity Aon's team has met "scores of China managers now and are building a buy list," he said.
Institutional investors conducting searches in 2019 are the ones with the relatively deep governance structures needed to sustain long-term commitments to a relatively volatile market segment. Among them, Sheffield, England-based Coal Pension Trustee Services, which manages two pension schemes with combined assets of more than £20 billion ($26.4 billion), is making its first allocation to China A shares, a spokeswoman confirmed March 7. Mark Walker, the Coal Pension's chief investment officer, couldn't be reached for comment, but the spokeswoman confirmed managers of A shares had already been selected. She declined to provide further details.
Market veterans predicted that the vanguard getting exposure to A shares now will be joined in coming years by a broader swath of institutional investors.
"In 10 years time," Mr. Amstad predicted, "we're going to look back at 2019 as the moment when things began to change," and A shares started to become an institutional, international and professional market.
For now, however, the reputation of A shares as a volatile market dominated by retail investors looks secure, even if analysts insist the growing presence of offshore asset owners will gradually make itself felt.
After sustaining the biggest losses of any major stock market last year — amid rising U.S.-China trade tensions and signs of slowing economic momentum on the mainland — China's Shanghai and Shenzhen A-shares markets have rebounded roughly 20% and 28%, respectively, since the start of the year.
Helping the rally: growing signs that U.S. and Chinese officials are eager to defuse the trade tensions stoked the year before, a shift in U.S. Federal Reserve policy away from rate hikes and the value many stocks listed on the mainland are offering in the wake of last year's market smackdown.
And now, the prospect of a wall of foreign money heading to Shanghai and Shenzhen has China's army of retail investors thinking "maybe I should buy too and get in front of this tsunami of money coming in," said Mr. Amstad.
In a March 10 research note, Goldman Sachs & Co.'s China strategy team said the about-face in sentiment fueled by expectations of a U.S.-China trade deal and $70 billion of MSCI-related foreign inflows, as well as growing support from Chinese policymakers could spark a "fear of missing out" rally capable of propelling further gains of 15% to 50% this year.
The market is putting on a real-time display of the volatile, sentiment-driven characteristics which turn "some people on and some people off," Cambridge Associates' Mr. Costello said.