4 May 2018
Inclusion of China A-shares in the MSCI EM Index
Starting in May 2018, effective with the RAM Emerging Markets Equities Fund’s May rebalancing, MSCI will include 222 large-cap, China A-shares in the MSCI Emerging Markets (EM) Index.
What is the weighting of the planned inclusion factor of the A-Shares?
Although the initial weighting of Chinese A-shares in the MSCI EM Index is relatively small (c.0.73%), the full impact (potentially 100% inclusion over the next decade) will be substantial. In our view, the inefficient nature of the A-Shares will, we believe, present an excellent opportunity for our stock-picking strategies (which look to capitalise on inefficiencies on a global basis). Our research suggests that further inclusion of A-Shares could represent a significant risk for the benchmark overall. Our Fund’s strategy here would be to invest via our counterparties in CFDs (should access not be possible via cash).
Allocation to China & HK in the RAM EME Fund average over the last quarter (by strategy):
In terms of our Strategy’s allocation to China & HK over the previous quarter*, all three maintain an underweight relative to the benchmark (30%). While our Momentum engine maintaining the largest weighting (26.2%), we have seen a general reduction in size over the quarter (peak of 26.2%, to a low of 22.9%). Our Value engine has a 25.8% allocation to China & HK, below the benchmark. Lastly our Defensive engine has the lowest relative allocation (22.8%). Again the reduction theme was evident here (peak of 25.8% to a low of 19.5%).
Potential Risks and Challenges
A consequence of the historically limited access to offshore investments here is the potential risk of overvaluation of the China A-Share market. As the integration of A-Shares increases over time, shorting and arbitrage opportunities could arise, leading to divergence in the valuations of the A- and H-Share markets. The market appears largely in favour of H-shares (trading at 23% discount, while also being cheaper to trade) versus A-shares listings for dual-listed stocks (see chart below).
As of March 2018, the valuation of the MSCI China A-Share Index was roughly double the valuation of the MSCI China H-Share Index:
Source: Bloomberg from 3rd May 2013 to 23rd April 2018.
Lack of Shorting Availability:
Given the high levels of valuation, our research indicates that we would rather identify short rather than long opportunities in the A-Shares universe. However, it is very difficult to capture these shorts and build a significant short position in the market, as borrowing availability in A-Shares is scarce given very low borrowable stock inventory.
In addition to the above, we can expect higher exchange fees and higher taxes, as well as higher commissions amounting to around 25bps of trading costs in A-shares, which could prove to be a costly exposure for our Strategies.
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