China has opened up to more foreign investors, providing greater access to its A-shares market. The loosened controls over the mainland Chinese shares could significantly impact broad emerging market indices and related exchange traded funds.
While China is trying to gradually liberalize its economy, index provider MSCI is closely monitoring China A-shares that trade on Shanghai and Shenzhen exchanges for inclusion in its global equity indices, writes Patricia Oey, senior analyst at Morningstar.
“The addition of China A-Shares would have a significant impact on the MSCI Emerging Markets Index,” Oey said. “China already accounts for 25%-30% (via Hong Kong-listed Chinese stocks) in this benchmark, so the addition of China A-Shares would result in a much larger China allocation.”
For ETF investors, the widely observed iShares MSCI Emerging Markets ETF (NYSEArca: EEM), which tracks the MSCI Emerging Markets Index, could make some changes ahead.
In its June 2015 Annual Market Classification Review announcement, MSCI stated that the limited market accessibility remains an obstacle to China A-shares inclusion in its indices. However, the index provider is open to China A-shares inclusion as China’s regulators provide more transparency and further ease capital mobility restrictions for foreign investors. [MSCI Delays Addition of China A-Shares to Global Indexes]
Meanwhile, the Vanguard Group has stated that it will add China A-shares to its Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO), which tracks the FTSE Emerging Index but will later switch to an index that includes China A-shares at a capped level. VWO’s exposure to Chinese A-shares could gradually increase as China frees up a greater portion of its domestic market to foreign investors. [China ETFs Surge After FTSE Move to Include A-Shares in Global Indexes]
Emerging market ETF investors, though, already have some exposure to China, but most broad ETFs only include Chinese H-shares, or Hong Kong-listed stocks, and Chinese equities listed in the U.S. For example, China makes up 26.6% of VWO and 23.6% of EEM.
Looking ahead, emerging market investors may be concerned about the larger allocation to China as funds add A-shares positions, especially given the recent bout of volatility in Chinese equities.
Potential investors will also have to consider other risks associated with greater China exposure. For instance, most listed Chinese companies are government-backed firms, which may put the interests of the state over profitability. Beijing is also very heavy handed with its policies as witnessed in the recent bout of volatility.
Nevertheless, the emerging market is trying to implement a wide range of economic reforms, notably a shift toward a more domestic-oriented growth model, and manage a slowing economy.
For more information on the developing economies, visit our emerging markets category.
Max Chen contributed to this article.