T. Rowe Price T. Rowe Price Trusty Logo

Price Point - In Brief

China's Alphabet Soup—Making Sense of MSCI's A-Share Announcement

Eric C. Moffett, Portfolio Manager, Asia Opportunities Equity Strategy

Executive Summary

  • Index provider MSCI recently announced that, from 2018, it will begin including China’s A-share stocks within its standard country and regional index series.
  • While the MSCI China Index has historically included China B-shares and offshore-listed share classes, China A-shares have been excluded from the MSCI China Index (and hence, the global indices that use the MSCI China Index as a component) due to restrictions on foreign investor access.
  • While regulators in China have sought to liberalize their capital markets in recent years by providing foreign investors with restricted access to China A-shares, the move by MSCI represents a significant milestone in China’s capital market development.
  • The China A-share market is home to a number of high-quality companies that are simply not available to offshore investors. Some of these companies are often overlooked by local investors as they are perceived as too boring. As such, they tend to trade at reasonable multiples, in our view, despite their high-quality and durable growth characteristics.

On June 21, 2017, after several years of consultation, index provider MSCI announced that it would begin including China’s A-share stocks within its standard country and regional index series. This added ingredient into the MSCI China Index represents a significant milestone in China’s capital market development. With this in mind, investment managers need to be asking this question: Are we ready for such a change?

China’s equity markets are split into a number of different share classes depending on whether the stocks are listed onshore or offshore, their denominated currency, their place of incorporation, whether they are government owned or private, and the city of listing. Historically, the MSCI China Index has included the offshore-listed share classes as well as B-shares, and there have been no restrictions on foreign ownership in these categories. China A-shares, however, have been excluded from the MSCI China Index (and hence, the global indices that use the MSCI China Index as a component) due to restrictions on foreign investor access. 

Figure 1: China Share Class Alphabet Soup
Mix A + B + H + Red-Chips + P-Chips + Overseas = 3,930 stocks1

1Sources: MSCI and Goldman Sachs; as of June 22, 2017.

In recent years, regulators in China have sought to liberalise their capital markets. Through the Qualified Foreign Institutional Investor (QFII), renminbi QFII (RQFII), and Stock Connect programs, foreign investors have gained some access to the A-share market through quota and trading systems. However, the June 21 announcement formally establishes greatly improved access, beginning a process that could potentially transform global equity index composition over the next decade.

WHAT IS HAPPENING?

MSCI announced that it would add the first allocation of mainland China A-shares into its indices in two tranches: one at the end of May 2018 and one in August 2018. This will impact all indices that include the MSCI China Index as a component, including, for example, the MSCI AC Asia ex Japan Index, the MSCI Emerging Markets Index, and the MSCI AC World Index. MSCI will initially include only a small subset of the full A-share universe. Of the 2,926 A-shares currently available,* 222 are expected to be included from 2018. These initial 222 stocks are large-cap companies available through the Stock Connect program and have not been subject to any prolonged suspensions over the last 12 months. MSCI will apply a 5% inclusion factor (IF)—a 2.5% IF applied at each of the May and August updates—a figure representing the approximate percentage of the A-share market available to foreign investors.

Over time, we anticipate that China’s weighting in global indices will gradually increase. Changes could be driven by two key variables: (1) market access will push up the IF and (2) MSCI’s methodology may revert to its standard global system, thereby bringing more mid- and small-cap companies into the benchmark. Looking ahead over the next 10-plus years, China A-shares could potentially come to represent a very large part of the global index.

Following the initial 5% IF, China A-shares will still only represent approximately 0.9% of the MSCI AC Asia ex Japan Index. However, at full inclusion (100% IF) and with the universe expanded to include mid-cap stocks, China A-shares could make up around 19% of the MSCI AC Asia ex Japan Index.2 China’s overall weighting in these indices would also rise sharply. It is important to note that these are estimates only, based on today’s index weights, and that this level of change is likely to occur over the next decade or more.

Figure 2: The A-Share Impact—MSCI AC Asia ex Japan Index 

Source: MSCI as of June 22, 2017. 

A-SHARE OPPORTUNITIES

For many foreign investors, the A-share market conjures up thoughts of retail-led boom-and-bust bubbles. But the reality is that it is also home to a considerable number of very high-quality companies that are simply not available to investors in the offshore markets. Broadly, we find these opportunities in the following categories:
 

  • Unique consumer franchises—the A-share market is home to some of China’s leading consumer brands, companies with long heritages and strong market positions. Key categories include alcohol, dairy products, home appliances, health care, and traditional Chinese medicine.
  • Technology leadership—high-end industrial companies that are leading China’s technological upgrade. Key categories include industrial automation, equipment/machinery, and environmental protection.
  • Strategic assets—businesses that benefit from government policy support and often have near monopolistic positions. Key categories include infrastructure, duty-free, and defense.
 
We find that these companies are often forgotten or overlooked by local retail investors as they are perceived as too boring. As such, they tend to trade at reasonable multiples, in our view, despite their high-quality and durable growth characteristics.
CHINA A-SHARE EXAMPLE—YUNNAN BAIYAO

The company produces “Baiyao,” a traditional Chinese medicine (TCM) blood coagulant that has been in existence for over 100 years and is one of the most trusted brands in China. The Baiyao formula is designated as a state secret. The company also distributes TCM and pharmaceutical products and has a consumer goods business, including the second largest-selling toothpaste in China. Another interesting aspect is that Yunnan Baiyao, which is a state-owned enterprise, has been at the forefront of reform in this area. Late in 2016, Yunnan Baiyao announced that a private company had taken a 50% stake in its parent company. We anticipate that this “mixed ownership” model will become increasingly prevalent in China over time.

WELL VERSED AND READY

At T. Rowe Price, idea generation and portfolio construction have never been tied to the vagaries and changeability associated with index providers. A number of our strategies and/or funds have been investing in the A-share market since 2009 when we received a QFII quota, with the T. Rowe Price Asia Opportunities Equity Strategy similarly investing in the market since its launch in May 2014. Since 2015, we have been making use of the Stock Connect program for most of our access, and we anticipate that this will remain our primary trading channel going forward.

We have formal research coverage of a number of A-share companies, and we will focus on continuing to grow that coverage over time. Under our sector-aligned research model, most analysts on the Asian team are already looking at the China A-share market as part of their regional opportunity set. However, we also now have two analysts dedicated to looking for stock opportunities in the A-share universe. Our goal will never be to cover all 2,926 A-share companies but, instead, it will be to focus on a smaller subset of liquid, high-quality companies.

As of July 31, 2017, the T. Rowe Price Asia Opportunities Equity Strategy’s exposure to China A-share companies represented 5.98% of the total portfolio. Looking forward, we are well placed to accommodate the upcoming change to our relevant MSCI benchmarks.


The specific securities identified and described above do not necessarily represent securities purchased or sold by T. Rowe Price. This information is not intended to be a recommendation to take any particular investment action and is subject to change. No assumptions should be made that the securities identified and discussed above were or will be profitable. 


Important Information

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

It is not intended for distribution to retail investors in any jurisdiction.

USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

T. ROWE PRICE, INVEST WITH CONFIDENCE and the Bighorn Sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.

201708-243526

Dismiss
Tap to dismiss

Download

Latest Date Range
Audience for the document: Share Class: Language of the document:
Download Cancel

Download

Share Class: Language of the document:
Download Cancel
Sign in to manage subscriptions for products, insights and email updates.
Continue with sign in?
To complete sign in and be redirected to your registered country, please select continue. Select cancel to remain on the current site.
Continue Cancel
Once registered, you'll be able to start subscribing.

Change Details

If you need to change your email address please contact us.
Subscriptions
OK
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®). TRP has been independently verified for the twenty one- year period ended June 30, 2017 by KPMG LLP. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest